EUR positioning leaves door open to euro slide

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By:
Peter Garnham
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The latest CFTC data showed EUR short positioning was at record levels, but proprietary positioning trackers of leading FX banks tell a different story.

With the possibility of a highly disruptive Greek exit from the Economic and Monetary Union (EMU) being discussed with alarming frequency, the downside risks for the EUR could hardly be more pronounced, but positioning indicators at leading FX banks do not seem to reflect a eurozone entering its darkest hour. Henrik Gullberg, FX strategist at Deutsche Bank, says the bank’s internal positioning analytics show the aggregate EUR short is considerably lower than the levels seen at the end of last year. Despite EURUSD recently breaking out of its stubborn 1.30-1.34 range, the short even receded since last week. The current EUR short on Deutsche's platform is in fact lower than 75% of those recorded during the past 12 months. Furthermore, short EUR positioning is predominantly in the speculative market segment, with real money funds showing much more moderate positions. “Despite the poor fundamentals in Europe, EUR positioning is still light enough not to hinder a three-four big-figure move lower,” says Gullberg. With or without any material change to the Greek saga, bearish sentiment in Europe is likely to gather momentum. “Even if Greece does stay within the system, following its elections next month it will remain a source of fiscal and potentially political shockwaves for the foreseeable future,” says Jane Foley, head of FX strategy at Rabobank. “Concerns about the future of the Spanish banking system will also continue to pose an independent threat to the coherence of the eurozone.” EURUSD broke lower to levels not seen since July 2010 on Thursday, prompted by poor German manufacturing PMI data and a sharp drop in the German, IFO survey, a measure of market confidence. EURUSD traded as low as $1.2520, as markets received a stark reminder of the underlying economic fragility, even within the eurozone core. Traders say $1.25 in EURUSD offers a good downside pivot handle, and a break below this psychological level could see markets target EURUSD’s 2010 low of $1.1977. At these levels, positioning will become much more relevant, barring a catastrophic event such as a Greek EMU exit, says Gullberg. Such an event would have unprecedented effects on the, so far, resilient euro, resulting from bank runs in the eurozone periphery and mass capital exodus of euro-denominated assets. “A slide well below the lows seen in 2010 is to be expected should the worst-case scenario materialize,” says Gullberg. However, at present, even among the speculative community, positioning in EUR remains relatively balanced, despite a worsening outlook surrounding Greece’s – as well as Spain’s – vulnerable economy and banking system. Citi’s PAIN index shows that hedge fund positioning on EUR, while net short, is still well above levels seen earlier this year.

Hedge fund EUR positioning
 
 Source: Citi
According to the head of FX trading at one leading European bank, the CFTC data capturing positioning in the futures market on the CME overstates the extent to which the market is short euros. “I’ve talked to a lot of people in different market segments and I’m yet to find someone who is truly short EUR,” he says. “As far as the leveraged community and real money community, it still seems they are generally underweight.” Some analysts believe the extreme CFTC data might reflect model trading accounts on the International Monetary Market (IMM) that are predominantly short EUR. Morgan Stanley’s internal flow data even shows a moderate EUR long, and also confirms that EUR short positions still tend to be heavily localized around the short-term speculative community, with other market segments’ positioning still relatively moderate. “The IMM is a small part of the market and these are showing an extreme reading, but it’s important to realize that other market segments are not showing the same levels,” says Ian Stannard, head of European FX strategy at Morgan Stanley.

“EURUSD’s break-out of its recent trading range is significant and as momentum builds in EUR negativity, I would expect to see positioning become more EUR negative and more broad based across the market,” says Stannard. “Current levels indicate there is considerable scope for the euro to move lower.”