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Foreign Exchange

FX research roundup: Is EUR/USD reversal a pause or just noise?

Three days of higher closes doesn’t exactly indicate a recovery but there could be signs that the EUR/USD sell-off has paused for breath.

Simon Derrick at BNY Mellon released a note Tuesday surveying the scene: (a) flow-wise the net buy back of euros that had been under way since the euro bottomed in mid-May now appears to have drawn to a close; (b) the latest IMM commitments of traders’ reports showed that short positioning is not hugely aggressive (short 37,257 contracts, admittedly, but “not a particularly dramatic number when considered in the context of the past 11.5 years. Indeed the average position for the entire period was long around 21,000 contracts whilst in May 2007 the net long position hit a rather more substantial 105,705 contracts”); (c) southern Europe/German sovereign spreads continue to widen; and (d) CDS prices, inevitably, were also bid (“In particular, we note that both the Spanish and the Italian five-year CDS prices have broken through to new all time highs in recent days”). There were few EUR positives.

But that was on Tuesday. By Thursday afternoon EUR/USD was trading at 1.2130, 2% off Monday’s 1.1875 low. That was when the chart below popped into the inbox from a friend who said: “I’m told this is not significant – but I think it might be”. It was the old 1M risk-reversal against spot chestnut. Risk-reversals are a supply demand phenomenon. Sure, they can be portrayed as an expectation of the direction in which volatilities will kick but equally, if the market gets extremely positioned, they are effectively stop-losses (Oct/Nov 2009) and also, of course, a move in the RR may just be an order going through. The pop back in the 1M RR might just be this but my feeling, and that of the friend who sent it to me, was that it was more of the ‘We’ve come a long way – lets buy a little bounce protection’ variety. If that’s so, a squeeze back to 1.25/1.27 is quite possible – but EUR/USD will still be in a downward trend.

If you were of a cynical bent, further evidence of the possibility of a move up was provided by Goldman on Wednesday evening when it moved it’s three-month target for EUR/USD down to 1.1500.


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