Why the euro is emerging as a brave bet against the dollar
Despite ongoing challenges in the euro zone, October saw the currency post its best month against the greenback in over a year
For those thinking of betting against the resilient dollar, the dilemma has been what to actually buy instead. The answer, for some, is at once obvious and brave: the euro.
While the euro-dollar pair is the most actively traded in the world, the prospects for Europe haven’t exactly stood out in recent times. The euro area has been contending with a sagging regional economy, the fallout from global trade disputes and risks stemming from Brexit uncertainty. It’s also home to large swaths of negative-yielding debt.
All that has acted as a drag on the euro, which has lagged behind most of its major peers this year. But as some of these challenges recede, the currency is once again becoming an attractive option for some buyers, and October saw it post its best month against the greenback since early 2018. Some investors are betting that gradual improvement in growth and progress in US-China talks could fan risk sentiment and drive the euro higher.
“A period of relative stability in trade negotiations” should buoy the currency, said Francesca Fornasari, a portfolio manager at Insight Investment, which has $844 billion (Dh3.1tn) in assets under management. There are also “expectations of an increased shift towards fiscal policy as a means to support growth in Europe”.
So far this year, it hasn’t been a good idea to bet against the dollar, even amid expectations the greenback would weaken. The dollar has consistently bounced back after soft periods and reached a more than two-year high in early October. Before last month, the euro fell in eight out of nine months.
Still, some of the year’s major headwinds for the euro are easing. Both Chinese and US officials have spoken positively about ongoing negotiations to reach a preliminary trade deal, which could further stimulate risk appetite and remove the haven bid for the greenback.
Furthermore, the Brexit deadline has been pushed back to January 31, removing the threat of a no-deal divorce this year. New European Central Bank President Christine Lagarde recently sounded a stronger tone than her predecessor on galvanising fiscal stimulus to facilitate growth.
JPMorgan Chase strategists led by Paul Meggyesi say they are “exploring opportunities” to go long the euro versus the dollar, but remain cautious in part because of the economic malaise. The group is encouraged by data showing the euro area posted a record annual surplus on its basic balance — a measure that includes current account, net equity and net foreign direct investment flows.
“This massive basic surplus should cushion the euro against future economic disappointment,” the strategists wrote in a note November 1.
Euro-zone economic data has been stronger than expected recently, with the Citi Economic Surprise Index for the region well off a bottom reached on October 10, though the gauge continues to show that reports are undershooting forecasts. A rebound in German factory orders added to signs that the euro-area economy has passed the worst of its recent troubles.
Price patterns also support the idea of a euro recovery, according to Citigroup technical strategists including Tom Fitzpatrick.
The euro-dollar pair in October completed a bullish outside month, meaning that month’s trading range was wider than the previous month’s, with prices closing at a higher level, the strategists said in a note November 1. On the other hand, the Bloomberg Dollar Spot Index and the US Dollar Index both posted bearish outside months, which suggests broad greenback weakness, they said.
Citi recommended an outright long position in the euro versus dollar on November 1 at $1.1146, with a stop loss at $1.1025. The trade has an initial target of $1.14 or higher, but could hit or exceed $1.18 by year-end, Mr Fitzpatrick said.
Meanwhile, Standard Chartered strategists Geoff Kendrick and Steve Englander say the market may have seen the lows in the currency pair, according to a note published November 6. They recommend a long position in the euro versus the dollar at $1.1090. The trade has a target of $1.1500 and a stop loss at $1.0950.
And sentiment among options traders is hovering near the most bullish for the euro against the dollar since July for time periods ranging from three months to one year.
The shared currency still faces challenges and not everyone is convinced its time to shine is near. Data this week showed that the 19-nation euro region’s manufacturing sector remained firmly in contraction, even as a purchasing managers’ index rose. Job losses accelerated and order books deteriorated.
The International Monetary Fund last week warned Europe to prepare emergency plans for an economic slump, as risks to the region’s outlook spread and monetary policy has all but exhausted its arsenal.
The region’s economy has been “hurt” by the US-China trade war and its manufacturing and inflation data remain sluggish, said Anne Mathias, global rates and FX strategist at Vanguard. Vanguard is still short the euro in its active funds where it has currency positions, Ms Mathias said, adding that she has a “neutral to bullish” stance on the greenback.
It doesn’t help that Europe’s yields are among the most negative in the world. Yield-hungry investors are attracted to US assets as the Federal Reserve pauses its rate-cutting cycle, with Treasury rates surging last week before dropping Wednesday.
Yet, the elements supporting the shared currency mitigate the headwinds, according to Sebastien Galy, macro strategist at Nordea Investment.
He forecasts that the euro should climb to $1.14 to $1.16 in the first half of next year.
“Once the Chinese growth machine starts to kick in again, exports from the euro zone will rise, supporting the euro, while the Chinese sell incoming dollars to buy euros,” he said. “That should drive” the shared currency higher.
Updated: November 10, 2019 08:41 AM