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Foreign Exchange

Euro shorts squeezed ahead of leaders’ summit

EURUSD recovered from a 16-month low as traders cut record bets against the single currency before a meeting between German chancellor Angela Merkel and her French counterpart.

Headlines • Holders of Greek bonds set to accept higher losses as negotiations over writing down Athens’ debt burden comes to a head – FT

• Short euro positions hit record high according to CFTC data

• German trade balance widens more than expected to €16.2 billion in November, up from €11.5 billion in October

• Hungarian prime minister Orban open to “any kind” of credit line to prop up financing

• Swiss unemployment rises to 3.1% in December

• Australian retail sales flat in November, against expectations for a rise of 0.4%

Market reaction and flows

The euro recovered from a 16-month low against the dollar and a 12-year trough against the yen on Monday as investors covered short positions ahead of a meeting between Angela Merkel and Nicolas Sarkozy.

EURUSD dropped to a low of $1.2666 in Asian trade, but rallied sharply after it failed to break down through option barriers around the $1.2650 level. Traders said buying interest from the Middle East encouraged European names to take out offers at the $1.2730 and $1.2750 levels.

Some put the recovery in the euro down to hopes that the German and French leaders would announce fresh details over a eurozone fiscal compact.

But data showing that speculators had built up record short positions in the euro suggested the rally was merely down to short covering, especially given eurozone leaders’ poor track record in getting to grips with the region’s debt crisis.

EURCHF traded down to a low of SFr1.2133, its lowest level since November, but talk of official bids around the SFr1.2125 level helped pull the cross higher.

Nevertheless, traders reported a fresh willingness to test the resolve of the SNB as it looks to enforce the SFr1.20 floor in EURCHF, while the amount of stale long EURCHF positions in the market also warranted caution, they said.

EURGBP also pulled higher from its lows around £0.8220, with traders noting large option barriers around the £0.8200 level. GBPUSD found support, however, trading higher from its lows around $1.5374 amid talk of demand related to a UK clearer’s dividend payment.

Meanwhile, AUDUSD fell to a low of $1.0145 after weaker-than-expected retail sales data, but was helped back above the $1.0200 level as Asian equities reacted positively to speculation that China was set to announce a further easing of banks’ reserve requirements.

USDJPY held steady around ¥76.80, having met with large speculative offers around ¥77.40 following last Friday’s stronger-than-expected US jobs report. A Japanese bank reported that USDJPY selling from exporters remained contained.

Elsewhere, the forint pulled further away from a record low against the euro after Hungarian prime minister Viktor Orban abandoned all previous objections to an IMF bailout, saying his government was open to “any kind” of credit line to prop up financing. EURHUF, which last week threatened the Ft325 level, stood at Fr313.50.


Data from the CFTC showed the value of net short euro positions on the Chicago Mercantile Exchange rose to a record $22.7 billion in the week to January 3, with net short positions rising to 138,900 contracts from 127,900 in the previous week.

Gross short euro positions increased to a record 179,000 contracts, while traders still held 40,000 long euro contracts, which was well above the record low of 4,000 long contracts registered in August 2004.

“Accordingly, the short position is extended but there are still longs in the market who are likely in the midst of capitulating,” says Camilla Sutton, chief currency strategist at Scotia Capital.

Notably, short euro positioning as a percentage of open interest stands near a record high.

Traders also more than doubled the net long yen position, bringing it to $5.6 billion, just 14% below the record long position reached in March 2008.

Investors cut net long dollar positions by $4.73 billion to $16.47 billion, but remained long of dollars against every currency except the yen, the Australian dollar and the New Zealand dollar.


The main movers in the vol market on Monday morning have been AUSUSD, where one-month vols are up 0.4 to 13.5 as spot touches 1.0150 for the first time since last month.

Although spot has rallied since, and traders see a squeeze as high as 1.0240/60, the break of the 1.0200 support is significant, and the next level to focus on is 1.0100. This should keep vols supported.

EURJPY was also higher on Monday, though it is predominantly in the short dates, due to date rolls over the weekend, rather than any specific flow.

In terms of EURUSD, it was a slow start to the week, with a mild offered tone after last week’s downtrend, where they drifted off from 13.4 last Monday to close at 12.55, which decayed to 13.1 through the weekend, and is currently trading at 12.6.

One-year closed at 14.65 and is currently trading in Europe at 14.55. Another trader notes the buying interest in 1.29 and 1.31 calls in the one-month, largely to protect existing short positioning in spot.

Of the biggest falls in vols on Monday, EM currencies dominate, and the risk-on tone prevails. USDRUB one-month is down 0.8 to 13.2 mid, with RUB risk reversals still firmly in favour of USD calls. USDZAR vols are also lower, though they remain the most expensive of all EM currency pairs. Rand realised vols are in freefall, says one trader, falling as low as 15 for the first time since September.

With implied trading with a spread of five vols above realised, Olivier Korber, an options strategist at Société Générale, argues that short gamma positions are attractive as long as risk-on prevails. His correlation analysis highlights that ZAR vol has recently been strongly correlated to oil volatility. The ration between USDZAR one-month and the OVX index has been very close to two for the past two-months. He says any deviation from this mean reversion could be an interesting signal.

What to look for

The pound will score well with the FX reserve managers in 2012.

Chris Turner, head of FX strategy at ING, says the depth of the UK sovereign debt market is attractive, especially compared with new reserve currencies such as those of Canada and Australia.

“We also expect fund managers to reduce eurozone debt exposure outright instead of migrating from the periphery of the region to the core,” he says.

Data from the UK authorities also show that foreigners were happy to increase exposure to gilts in recent quarters, providing a vote of confidence to the UK’s fiscal austerity plans.

“In all, we do not see 2012 conditions justifying sterling as being this weak, especially against the euro,” says Turner. “Recent EURGBP losses are part of a 12 to 18-month trend that will carry it to £0.7500.”

Spot 6.30 EST

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