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EUR Up, but WHY? - Global Exchanges

FICC Podcasts avril 20, 2021
FICC Podcasts avril 20, 2021

 

Disponible en anglais seulement

In this episode, we discuss the surprising rally in the EURUSD exchange through 1.20 and associated moves in other pairs.


 

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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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*Disponible en anglais seulement

Greg Anderson:

Hi, welcome to episode seven of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my co-host, Stephen Gallo, and I, will be talking about the surprising rally in Eurodollar through 1.20 and associated moves in other pairs. The title for this episode is, Euro Up, But Why?

Stephen Gallo:

Hi, I'm Steven Gallo, a London-based FX strategist. Welcome to Global Exchanges presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York-based FX strategist. I'm Stephen's cohost.

Stephen Gallo:

In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates or subsidiaries.

Greg Anderson:

So Stephen, here we are on April 20th and I'm staring at my screen and it says Eurodollar is trading at, call it 1.2050. And I've got to admit that when we were at 1.17 and falling just three weeks ago, I didn't see this move coming. Did you see it coming? And do you think the market saw it coming? And basically, I guess, I just want to ask why?

Stephen Gallo:

No, Greg, you're absolutely right to call me out for that. My one month view for Eurodollar was set at a lower rate than where the pair is currently now, 1.20 in change, as you said in your segment. I think the overall market though is probably a bit surprised too. In other words, I'm not the only one that made the mistake here. If you go back through the positioning data of leveraged funds and look at where we were for the week ending in April 6th, leveraged funds increased their net short position in Eurodollar for that week, which means they were probably selling rallies in the pair when it was between 1.1750 and 1.1850 give or take. So I think it's caught a number of FX investors off guard.

Stephen Gallo:

To finish up on your comments and your questions, Greg, I don't think there is one specific reason for this move. As is often the case in FX, a confluence of factors is generally responsible for a move like this, but I think what we should also do is put the move into context. If you look at Eurodollar on a quarter to date basis, so far in Q2, it's about the middle of the G10 pack. It's not the best performing currency. And it's not the worst performing currency, but maybe more importantly, when you look on a week over week basis, euro is towards the bottom of the pack, currencies like kiwi, NOK and sterling have significantly outperformed the euro on a week over week basis. I assume the gap between where the euro did perform and where those other currencies performed at the top of the pack is because of the euros funding attributes. In that context, really Greg, the picture we have here, it's the whole pack of G10 currencies has basically risen versus the US dollar, quarter to date.

Greg Anderson:

What you're really saying is that this isn't a euro move, it's a US dollar move?

Stephen Gallo:

So far, yes Greg, I think that's right. I think this is a dollar move. There are some medium-term, possibly euro positive risks we have to consider, which we might be talking about later on this podcast, but I think the main thing to point out is that this has been a dollar move. And it seems to me like the catalyst was the fact that longer-term US. Treasury yields have settled down. They seem to be tightening up in a range. What do you think about that Greg?

Greg Anderson:

Steven, I think you've nailed it by saying that the settling of US. yields has helped turn the tide in the US dollar. I think that's absolutely right. Although there is no mechanical link between bond yields and especially long-term tenor bond yields and exchange rates. Spiking yields gave the FX market a narrative that justified flipping from short dollars at the start of the year to a longer position, as the yield spike extended in February and March. Now in April, it certainly appears that long-term yields have put in at least a temporary high and are settling in a range. With that I think the US dollar's negative flow picture has resurfaced as an important counter narrative, and that is dragging the dollar lower and should continue to do so unless the yield spike re-emerges. The only thing is, I can't fully explain why the yield spike ended, because the U.S's economic data has just gotten better and better. What about Europe's data over the past few weeks, Steven, has it gotten better?

Stephen Gallo:

No, not in a significant way that we could make the conclusion that the tides have turned from a macro perspective in Europe, but I think it is worth noting that investor expectations for late Q2, early Q3 in Europe, have firmed up a bit in terms of the economic rebound coming. But, Greg with so many legacy issues in the Eurozone, and so many factors restraining growth, I don't think that alone has been responsible for the rally in euro dollar. The other thing worth pointing out is that this rally in euro dollar has coincided with a reduction in market expectations for Fed rate hikes in 2023. So some of those hikes have been pulled out of the euro dollar curve, and that has definitely been a function of the Fed's dovish language.

Stephen Gallo:

So again, I think there is a lot coming from the dollar side of the equation here. Maybe the Euro's liquidity profile effectively means the currency strengthens by default, but I think this has largely been a dollar move. The other important factor, which I'll just mention, which neither one of us have mentioned yet that separates April from March, is that the PBOC has allowed dollar RMB to drift lower as dollar longs have covered, as long-term U.S yields have backed off. And that allows the dollar weakness to, in a sense feed off itself and spread to other currencies. So that's a factor that's important here, too.

Greg Anderson:

I'm glad you brought up the world's biggest reserve manager and the reserve manager that EM central banks tend to mimic. As a group, I don't think EM central banks were comfortable with the pace of US dollar depreciation in the second half of 2020. Based on January and February data, EM central banks were buying dollars in January and February to try and boost the Greenback, which by March didn't appear to be necessary anymore. I'm wondering out loud here, because we don't have everyone's reserves data from March, let alone April. But I'm thinking that probably EM central banks have decided to basically go neutral for Q2 and neither buy nor sell US dollars. And again, that leaves bear the US's negative flow picture, particularly vis-a-vis Asia.

Stephen Gallo:

So just to migrate back over to the euro and the flows picture there, the one thing that stands out in my opinion is that net portfolio investment outflows for around 730 billion euros in the sixth month through February, quite a large number. So the Eurozone probably fully recycled its current account surplus. And then some over that period, important to point out that we know that these flows tend to be mostly currency hedge, but what we probably can say with a reasonable amount of certainty is that Europe core flows overall on the financial account side, weren't euro positive for most of Q1. I suppose it's possible the flow has became more euro supportive in late March or April. And with the negative core flows picture for the US dollar caused euro dollar to rally, but we'll have to wait for the data to confirm this.

Greg Anderson:

It sounds like you aren't convinced that this euro dollar rally is anything other than a short squeeze. So if that's the case in euro dollar, I've got to ask you, what's your view on the euro CAD rally? Looking at the euro side of the exchange rate. Do you see any fundamental reason for the rally from sub 1.48, just a couple of weeks ago to nearly 1.52 today?

Stephen Gallo:

You know what, Greg, you may find this a little bit surprising, but I actually think the move in euro CAD is indirectly related to the fact that US long-term yields, dollar long-term yields, have stabilized, they've steadied here. And if anything, they're moving a bit lower. And what that has effectively done has meant there's been less follow through on the downside in euro dollar. So as short positions in that access have been covered or squared up, it's boosted the euro across the board, and some of these euro funded carry trades have seen pretty significant short squeezes. We seem to be in the middle of one right now, in the pair you mentioned in euro CAD. What about your take? What about the Canada side of the equation here? The CAD side of the equation, is it any more interesting?

Greg Anderson:

Coming at it from the CAD side of the cross, my take on the euro CAD bounce is that it is purely a short squeeze. My number one fundamental for the pair is the price of oil, with Canada being a net exporter and Europe being a net importer. There has been no oil price dip corresponding with this euro CAD rally. In fact, oil prices have firmed a bit. With that, although I know that this short squeeze has the potential to extend a bit further. I still think that this is an attractive juncture to reenter euro CAD shorts, especially ahead of this week's BOC and ECB meetings, which I think may present a pretty stark contrast.

Stephen Gallo:

Right? So bank of Canada tomorrow, Greg, what are your expectations?

Greg Anderson:

Well, Stephen, it's a quarterly MPR update meeting. So we get the whole deal in terms of an interest rate announcement, forecast updates, and the press conference. The BOC had extremely conservative economic forecasts in their January MPR. So those are going to have to go up and the market knows it. The BOC isn't going to do anything to its base rate, and the market knows that. The crux of potential drama for this meeting surrounds the BOC's bond purchase program. Our house view is that the BOC will taper its pace of bond purchases from 4 billion CAD per week to 3 billion. That view is more or less in line with consensus. Although we would admit, there is certainly a chance to the BOC doesn't taper tomorrow, and instead delays by one or two meetings. They've got to do it eventually due to technical issues in the bond market. So either the BOC tapers or perhaps the market for a future taper. In the event of a taper, I think CAD should rally to catch up to its oil fundamental.

Greg Anderson:

That means that dollar CAD should move back down below 1.25 the figure, probably somewhere between 1.2450 and 1.25. Yes, if there is no taper, we could get a pop-up above 1.2650, but I don't think it would stay there for very long. IMA data didn't show leveraged money as being short dollar CAD. And if by chance, such a position had been built up over the past few days, today's dollar CAD rally above 1.26, presumably white said positions out. From my perspective, the market enters this event pretty square. So where we think there will be a taper, I think dollar CAD is most likely to drop hard tomorrow. That's the BOC in a nutshell, what are your thoughts on Thursday's ECB meeting?

Stephen Gallo:

Well, in order to dive into that issue, Greg, I've got to set the backdrop by noting that a lot of how the ECB strategizes its moves over the next six to 12 months, will I think be heavily shaped by fiscal policy and the degree to which the ECB policy stance marries up with the fiscal picture. So the first point to make in this regard is that the ratification process for the EU's recovery fund has stalled. The disbursements from that fund are not going to add a huge amount to GDP growth this year anyway, but the fund will have an impact on debt issuance within the EU. And that is important to the ECB. The second point to make is that bond markets in Europe seem to be starting to wake up to the fiscal risks surrounding the German elections in September, nothing huge going on here yet, but investors are starting to think about it.

Stephen Gallo:

I think the impact of these risks on the euro will be better covered as separate podcasts. But my point is that because the situation is in flux, I don't think the ECB will want to pre-commit to either a slower or faster pace of asset purchases at this stage of the game. Maybe there's a risk that they could hint at a future reduction in the pace of asset purchases. But I think the central bank will continue to frame that in the context of all the flexibility it has with its various programs rather than a pre-commitment.

Greg Anderson:

So what does all this mean for euro dollar?

Stephen Gallo:

Well, I don't think this one, this ECB rate decision is going to be a range breaker, Greg, and by range, I'm kind of referring to 1.19 to 1.22 give or take. I don't think that's going to happen this week, but I think the more important point to make, and this is where I think it's necessary to feed in other asset classes into the FX picture. The main point I would make is that ECB dovishness is not as big of a deal anymore for downside in euro dollar because long-term US yields have stabilized.

Greg Anderson:

Great insight, Steven. I think that's a good note for us to end on. Thank you listeners for sticking with us through the bitter end. We'll be back again next Tuesday, April 27th for our next episode.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FIC Macro Strategy group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

This podcast has been prepared with the assistance of employees of bank of Montreal, BMO Nesbitt Burns Inc, and BMO Capital Markets Corporation, together BMO, who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts. Not withstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or suggestion that any investment or strategy referenced herein maybe suitable for you.

Speaker 3:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe



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