Barclays FX strategy team says it doesn’t expect any meaningful political steps toward a viable long-term solution to the periphery debt crisis, while its economists are forecasting a further deterioration of the region’s economic fundamentals. Next week’s PMI data for Germany and France is expected to be weak, while the composite index of 17 countries of the eurozone (E17) is expected to contract again this week, having fallen from 57 to 49.8 since April.
At the same time, the US dollar is experiencing a mini revival, in part due to expectations that the Federal Reserve will engage in “operation twist,” rather than expand its balance sheet with more quantitative easing. Furthermore, in a report published last week, Morgan Stanley said a slow-down in central bank reserve diversification would likely reduce flows into euros.
“We’d prefer to express our bearish view by buying a EURUSD put spread rather than be in the spot market” says Sara Yates, an FX strategist at Barclays. "We are in a situation where the market is short, and if there was some positive news, albeit quite small, you could easily get a short squeeze and the euro could gap.”
UBS positioning data also backs this view. With the exception of the week ending Sept. 9, net flow in the EURUSD has been negative for the last eight weeks, according to UBS G-9 weekly flow data. Last week net flow in EURUSD was -$2.2 billion dollars, with the majority of short positions coming from asset management investors.
Yates suggests buying 1 month-to- 3month put spreads. Indicatively, an investor could buy a one-month euro put, dollar call with a strike of 1.34 and sell a euro put dollar call at a strike of 1.30, for a cost of 100 basis points.
In a deteriorating global economic situation Barclays analysts see increasing value in being defensively positioned. They recommend buying a basket of USD and JPY against a basket of EUR and GBP, currencies likely to be vulnerable in the current climate.
“This basket trade offers a good hedge if risk appetite deteriorates more rapidly than expected, given either negative economic surprises or renewed market pressures in Europe” says Yates.