EUR/USD has undergone a painful squeeze over the last few weeks. We do not
think this has much more to run and believe these are good levels to re-enter
First, history suggests that counter- moves in dollar trends rarely go beyond
the current correction. Of the ten largest dollar moves in history, all but one
have witnessed a squeeze greater than 10% (chart 1). The current 9%
correction is very close to historical experience, suggesting we should be at (or
very close to) the end of the squeeze.
Second, positioning is much cleaner. FX trading volumes rose during the last
two weeks’ EUR/USD rally (see DBFX volume report to be published this
week), while the beta of an index of FX fund manager returns to the dollar has
already reverted to its medium-term average (chart 2). IMM data, though
lagged, also show ongoing position reduction.
Third, the risks are skewed to a renewed turn of relative growth and monetary
policy expectations in favour of the USD. EU-US data surprises are at extremes
in favour of Europe and have already started to turn (chart 3, see other page).
In turn, the market is now pricing both the first Fed rate hike and the end of
ECB QE by December 2015, which seems too dovish and hawkish
respectively. The next move in EU-US rate differentials is therefore likely to be
down, not up (chart 4).
In sum, our EUR/USD forecast of parity by year-end remains unchanged and
we believe these are good levels to re-enter EUR/USD shorts.