Any pullback in the EUR in the wake of the European Central Bank’s (ECB) policy meeting is unlikely to be violent, given that investors have built up long positions in the single currency at much lower levels than many would have imagined.
Some were always looking for the market to be disappointed by the announcement from Mario Draghi, ECB president, of the central bank’s new bond-buying programme.
The ECB added a new acronym to its armoury by announcing its OMT (outright monetary transaction) scheme in a bid to steady the eurozone’s debt markets and make good on Draghi’s pledge to do whatever it takes to ensure the survival of the single currency.
The central bank said it would engage in unlimited bond buying at the short end of the market, if a peripheral eurozone country requested a bailout programme.
However, for many, the fact there remains a large obstacle to its implementation – that neither Spain nor Italy appear prepared to request the aid – meant the programme was never destined to be a game-changer for the eurozone debt crisis.
There is also the potential hurdle of the German constitutional court to overcome, not to mention, after many weeks of speculation – Draghi made his promise in late July – an element of “buy the rumour, sell the fact” in the reaction from EURUSD.
Still, Citi says the way the market has built up its long positions in the euro in recent weeks means investors are unlikely to be forced out of positions until EURUSD trades a lot lower than current levels.
Both the bank’s real-time positioning indicators show EUR buying during the past month and a half.
While it is still in negative territory, the CitiFX PAIN indicator, which tracks the correlation between hedge fund returns and moves in the exchange rate, has been climbing since mid-July. The bank says the shift from a strong negative correlation to a weak one suggests that funds covered their short positions in the single currency as EURUSD moved higher.
Furthermore, the CitiFX Positioning Indicator (CFPI), which measures positioning among funds on the CitiFX Access platform and is weighted more heavily towards active trading, continues to trade in positive territory after a similar surge to the PAIN indicator.
The PAIN indicator hit a low on July 16 and has risen steadily. Meanwhile, the CFPI made a base on July 20 and peaked on August 23, before easing back.
CitiFX PAIN and positioning indicators - EUR
Todd Elmer, FX strategist at Citi, notes that EURUSD traded in between $1.21 and $1.2350 for the bulk of that period, only sustaining a move higher on August 20.
That implies the bulk of EUR buying might have occurred at relatively attractive levels compared with recent ranges, with the small pullback in the CFPI pointing to increased reluctance from investors to chase the latest move higher in the single currency.
Elmer says that implies the real pain for investors will come only on a move back beneath $1.2350 in EURUSD, further away from the current level around $1.26 than many would imagine.
“Longer EUR positioning does point to headwinds to a continued up move, and increased profit-taking could trigger some losses,” he says.
“However, any EUR down move on ECB disappointment could ultimately be more measured than some anticipate, since it doesn’t look like longs are now on the cusp of being stopped out.”