We cautioned a few weeks ago that a little perspective was probably needed when discussing the “everyone is shorting the euro” story.
The CFTC data on which the stories were based, we argued, only reflected of a small sliver of the OTC forex market.
According to JP Morgan’s John Normand, however, apparently not; the data is indeed reflective. One way of corroborating how much so is by looking at the bearish/bullish skew, or apparent “risk reversal”, present in the FX options pricing.
As the following chart shows, recent delta reversals do seem to confirm the CFTC shorting argument:
In other words, players in the OTC market are just as short the euro as those trading the futures market.
That doesn’t necessarily mean Normand thinks there’s much more downward pressure to come on the euro, however. As noted in the same report:
Against a backdrop of record euro shorts, whether measured directly through the IMMs or indirectly though EUR/USD risk reversals (chart 2), we doubt this issue will exert sustained, downward pressure on the euro this spring. The euro could still fall if European growth continued to underperform the US and rate spreads narrowed, or if equity markets fell further. (The currency still behaves cyclically, despite bears’ refusal to acknowledge EUR/USD’s high correlation with commodity currencies and emerging markets through equity inflows and central bank reserve diversification).
But even further spread compression and equity market declines would only move EUR/USD to the low 1.30s. A simple regression of EUR/USD on rate spreads (Euro – US), sovereign spreads (Greece – Germany) and volatility (VIX), implies that EUR/USD declines 8 cents for every 100bp narrowing in Euro vs US spreads, and 6 cents for every 10 point rise in VIX. Spreads currently stand at 42bp and the VIX at 18. A 50bp move in rate differentials against Europe would weaken EUR/USD by 4 cents, and a 5 point increase in the VIX would lower EUR/USD by another 3 cents. Both scenarios seem extreme given that European data are starting to stabilise. If, in addition, Greece indeed has been ring-fenced by its own efforts to tighten fiscal policy, then EUR/USD has probably seen its lows until Fed tightening looks more imminent later this year.
Short squeeze anyone?
Related links:
No, not everyone is shorting the euro – FT Alphaville
‘Talk of a GBP crisis seems like hysterical claptrap’- FT Alphaville
Hedge funds to ratchet up euro bets - FT