Why do I think the EURUSD is a sell...??

Why do I think the EURUSD is a sell??

I do understand it is a non-consensus trade against all the big players of the FX market which their objectives vary between 1.25 and 1.30 for Q4, (yes, it could be the same situation as the beginning of 2017, when the majority thought we were going to parity in EURUSD….)

I also acknowledge the European economy has improved substantially in the last few years, due to the ultra-expansive monetary policy that the ECB has put in place at the beginning of 2015.

I also know that the American politics have strongly broken into the currency markets since Trump arrived to the White House, in order to counteract the American trade deficit with the rest of the world, especially with China and Europe. Therefore the US needs a weak USD (in my opinion it may work in the short term but, I disagree this strategy will benefit the US in the long term considering we are in a global economy)

Despite these arguments, I think that the appreciation of 20% experienced by the EURUSD in the last year deserves more than a small correction.

As an example, I remember perfectly the day of the American elections and the victory of the always controversial Donald Trump. His victory was going to be a blow to the world markets and the USD would suffer like never before (the end of the world was coming!). Indeed the USD was heavily punished after knowing the election result, but little by little it recovered ground to finish the day above where it had begun!! 
The rest of the story is already well known, an USD Index rise of just over 7% in just two months (USDJPY + 17.25% from the lows, from 101 to 118 ...). At that time, I also argued that the spectacular rise in the USDJPY was unsustainable, against the opinion of the big banks with 125 objectives at that time.

We are in changing markets and what seems clear today, tomorrow is not so.

The arguments that support my view are the following:

1) Macro Data: Recent data shows a weakness of macroeconomics in the Eurozone. Compared to other periods, this time we have seen a bigger decrease in the Economic Surprise Index.

Citi Economic Surprise Index – Eurozone (white) Vx EURUSD (orange)

)      2) Positioning: Long speculative positions in euros are at historical highs. The market is much more long positioned than when the EURUSD traded close to 1.60 in 2008.

This position will suffer if EURUSD drops below important support levels (1.2210 and 1.2150) leading to close positions, profit taking by investors accelerating the downward move.

This type of adjustment takes time, so patience is needed. 

CFTC EUR Non Comercial net position (white) Vs EURUSD (orange)

     3) Reserve diversification: Much has been said during this year about the diversification of the Central Banks reserves (especially Asian CB) are doing buying EUR and selling USD. Surprisingly, the last report published by the IMF (COFER) with information from the last quarter of 2017, shows how the reserves in euros have grown much less than estimated (from 20.05% to 20.15%). The main reason comes from the appreciation experienced since last year, which means that the reserves are increasing only by valuation.

So one of the arguments by which the speculators have positioned themselves in favor of the Euro seems to have lost weight.

   4) Oil: EURUSD and Oil have a positive correlation (please see graph underneath), losing strength at the beginning of 2017 and correlating positively again from the second quarter. Recently, Saudi Arabia has communicated that they would like to see the price of oil around 100 USD per barrel. It seems that we have already forgotten the American fracking sector and its ability to increase the offer (one of the factors why the Saudies knocked down the price in 2014).

In my opinion the fundamentals of the oil are not supporting such high prices. 
The risk is that, in an intervened market as the “black gold” is, OPEC couuld cut the production further shooting the price up.
The consequences in the medium term would be negative for the global economy, questioning the monetary policy normalitation being carried out by central banks.

EURUSD Vs Oil daily chart

And, what about the USD??

     5) FED: The Federal Reserve is on its course of interest rates normalization. Market, as the dots, discount two more increases from here to the end of 2018. But if inflationary pressure increases, we should probably see an additional one, with an important impact in the USD.

US CPI inflation

More interesting to analyze is the decoupling between US and Germany rate differential. That correlation was clearly broken by mid 2017 after French elections.

Last time we had this situation, it took EURUSD 10 months to converge again with rates.

DEUSD10Y (whithe) Vs EURUSD (inverse/orange)

DEUSD2Y (whithe) Vs EURUSD (inverse/orange)

 5)      USD Repatriation: Tax reform in the US will lead to a repatriation of 3.5$Trn foreign earnings, part of these are in USD assets and other in different currencies, so we will start to see some FX hedging by companies in the next months.

     6) Technical Analisys: A close below 1.2330 will be a bearish signal. Levels to have an eye are 1.2210 and most important 1.2150. If both are broken, 1.19/1.20 could be easily seen without discarding 1.18ish.

 EURUSD Daily Chart

EURUSD Daily Ichimoku Chart. A close below the cloud (1.2240) would be a bearish

EURUSD Weekly chart. Upside move stopped near the 61.8% Fibonacci retracement with bearish divergence in the RSI

EURUSD Monthly Chart. A close above the 200MA (1.25 now) would be a bullish signal

All this analysis makes me think that we are close to a greater correction in the single currency. 

A risk to take into account will be the verbal declarations from American authorities if the USD appreciates so quick (only a remind to Trump and Mnuchin: DXY has seen a fall of 12% in little more than a year).

As I said, only a close above the high seen in January would change my vision.

Any comment will be welcome

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria

Daily Comment

Thks to “Heat” for his thoughts…

Q1 is behind us and we can confirm that it has been one of the least volatile quarters ever in foreign exchange markets (February and March arguably boring), after a surprising initial USD selloff in January based on US deficit expansion and most likely reserves portfolio reallocation from Central Banks, Dollar index DXY has been trading sideways in a narrow range (88.50-90.50). Conversely EurUsd traded between 1.2250-1.25, UsdJpy 107.5-105, sterling 1.39-1.42 on the wide…  even Latam currencies remained pretty stable despite USD yields going higher (10Y UST reached 2.94%) and stocks drifting lower which both are good drivers for EM currencies, however we are seeing historic correlations performing poorly in recent months.

Does this lack of volatility makes sense? I´m prone to think that yes it does, seems that we´ve reached an equilibrium point where the synchronized growth is on track with low inflation levels so in everyone’s interest we´ve been in “don´t hurt ourserlves” mode and Central Bankers messages have been neutral. Looking at the Euro,  there is a quite positive sentiment in markets regarding Eurozone economy and the structural CA Eurozone surplus should support the common currency over the medium term, however total absence of inflation pressures (lower inflation set of data in recent weeks) will make any eurusd rally short lived (disinflationary effect of strong currency). Everyday I find it more difficult to believe that Draghi will be able to make any rate hike before he leaves the office by December 2019.

Do I expect to have similar level of volatility in Q2? I don´t think so (being honest I hope not either) thanks to the US stocks market which in my opinion will be the main market driver in coming months. There are several factors which are spooking investors and could lead to a deeper selloff:

·         Trade Wars between Trump and China, at the time of writing China has imposed tariffs on 106 new products including cars or tobacco (Trump´s twitter account followers will love his next entries). The total sum of tariffs imposed to each other is close to 50bn usd, still modest figure given the size of trade between the two but if conflict worsened this would massively erode both economies.

·         Tech companies valuations seems “high” (Amazon P/E ratio >300) and reputational risks are arising (Facebook & Tesla). Don´t forget that top5 US companies by Market Cap belong to IT sector.

·         Pure technical levels. Monday´s close below DMA200 level has taken market attention, additionally S&P is struggling to keep the long term uptrend, clear break of 2550 in s&p500 would leave an ugly scenario ahead of us for risk assets.

It´s true that there never was a clear bear market without the economy entering in a recession (not likely now), however it´s true also that there never was a bull market (almost ten years now) driven by such an extraordinary expansion of Central Banks balance sheet. Said that it´s reasonable to think that once that free liquidity start to vanish risk assets should retrace somewhat.

If that scenario materialized I would expect safe haven currencies such jpy or chf perform well, Latam currencies would suffer and US dollar should be supported, however protectionist rhetoric from US administration could offset buying forces, being honest I think eurusd will trade range bound for the remainder of the year. Treasuries would rally on first place as usual but we are waiting for lower levels for entry short again (2.55%-2.60% target). New Fed Chair Powell showed strong confidence in the US economy  on his first appearance in the March FOMC, Fed members projections were revised up also, makes me think that unless a strong correction in stocks starts to erode consumer confidence and consumption rapidly; the gradual path of rate hikes will continue, so given current market pricing of less than 3hikes until Dec2020 there isn´t too much room for US yields to go lower.

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria