What's Next For EUR/USD?

Over the past year the Euro has been a favourite short in our FX portfolio. I’ve discussed the fundamental reasoning in many articles on numerous occasions, whilst Alex made the bold prediction of EUR/USD heading the parity in an interview in September last year. That statement isn’t looking so bold now the single currency is trading right on the 1.0600 handle!

Currently short EUR/USD is one of the consensus trades in the FX market along with long the S&P. As traders we have to make re-evaluate our positioning and decide whether we want to maintain our current exposure, or adjust our risk in some way. In order to do this we have to consider the fundamental landscape for both the Euro and USD as individual investments.

The EURO

Ok, first let’s look at the Euro. The economic data in the region is showing signs of improvement and stability as the European Economic Sentiment Indicator for the Euro-area has moved into above long term average territory with a reading of 103.9. However, weakness in the Core (France) is a cause for concern.

The main concern for the Euro is Greece and the ongoing negotiations with the EU. Greece wants to focus their efforts tax evasion and corruption in a bid to raise funds. As expected the EU prefer the efforts to be directed on structural reforms and fiscal plans to cut costs and spending.

No solution has been found, and Greece managed to pay off their recent obligation on the 9th April without a hitch. But the question is how they will deal with the next repayments in May, June and July without additional funding? The longer this question goes unanswered, the more anxious investors will become over the Euro.

The latest JP Morgan research report suggests the Sentix Euro Break-up Index had 36.5% of respondents expected a country to leave the Euro, and 96% of these respondents though this country would be Greece. To put that in to context in 2012 the same index stood at 73%. What does this tell us? Well, it tells me that the market hasn’t fully priced in the risk of a Greek exit, and there is scope for further declines.

Whilst we’re talking about the Euro let’s consider its appeal as a funding currency. It no longer rallies on good news and is underpinned by the ECB and their decision to begin the own quantitative easing program. Not good for the Euro.

A Quick Glance at the USD:

The U.S growth and monetary policy story has been the driving force behind moves in the FX market over the past 6 months. Investors have been betting on the continued divergence in growth and monetary policy between the Federal Reserve and the likes of the ECB, RBA and BOE, making long USD the most popular trade amongst the investment community

After last Friday’s dismal Non-Farm Payroll number the market is now wondering how this is going to impact the prospects of the Fed raising rates. We need to look at the data objectively and decide if the U.S economy has taken a turn for the worse, and consider how this impacts the long USD play that has paid us so well.

The ISM Manufacturing PMI - this leading indicator of U.S growth, has been trending lower despite being in expansion territory. The survey peaked in November 2014 and has since declined each month following, with the latest release coming in at 51.5, worryingly close to 50.0 (boom/bust).

Historically, significant developments in the ISM Manufacturing PMI lead to major moves in the S&P500 as investors react to U.S growth outlook. With this in mind a break below 50.0 after almost 6 months of trending lower will flag a real concern over growth prospects for the U.S.

The qualitative aspect of the report points out a number of headwinds facing the U.S economy including the harsh weather conditions, West Port disruptions along with bad weather and a strong USD. We can argue that 3 of the 4 headwinds are temporary in nature, like winter weather and port disruptions. As we head into spring these temporary issues will cease to exist (apart from strong USD).

A strong positive for the U.S economy is the optimism of the consumer. Consumer sentiment data is reflecting a positive outlook; this bodes well for future spending. In fact, latest data showed increases in Car Sales and Motor Vehicle Production. People only buy cars when they have disposable income and are positive about the future.

Building Permits, a leading indicator of the U.S economy continues to show robust growth. We can take this as a sign that banks are willing and able to lend, another good sign for U.S growth.

Conclusion

No doubt the U.S economy has softened somewhat, but we expect this temporary blip to be a result of temporary factors that are likely to dissipate as the year progresses.

Let’s not forget the USD in back by the Federal Reserve, a central bank on the path towards ‘normalising’ monetary policy. Yes, the chances are that they will wait until Q3 to raise rates, but it still puts them way ahead of their counterparts.

The Euro has experienced an improvement in economic data, and sentiment is now above long term trend. However, the uncertainty that comes with the Greece debacle means investors are cautious about holding the single currency.

We’ve maintained our short EUR/USD bias, but will wait for another break and close below major support at 1.0450 before adding another short and rolling our stop up.