Even Euro Pessimists May be Under-Pricing the Currency’s Dangers

(Bloomberg) -- Currency traders are paying little heed to analysts’ calls for a stronger euro, positioning instead for more weakness via options. But even they may be underestimating how rapidly it could tumble in the coming months.

The currency’s prospects are mired in multiple risks -- not least the European Union’s inability to assemble a fiscal response to the pandemic and the threat of a market meltdown in peripheral euro area, hit hard by the coronavirus.

A preference for structural long positions among institutional investors also weighs against the euro. So do haven bids for the dollar amid the continuing virus crisis. Legal complications surrounding the European Central Bank’s emergency bond-buying program are no help either. If anything, all these risks suggest the common curency is headed for fresh cycle lows.

Options traders have accounted for this scenario, yet bets appear concentrated either close to current spot levels or are hedges against a plunge below parity. Depository Trust & Clearing Corporation data -- on vanilla options that went through in the past month -- show there are few trades that bet on a drop below $1.0650. That suggests traders may need to chase price action lower, should the year-to-date low of $1.0636 give way.

The euro traded around $1.0790 on Thursday, little changed for the day but down 3.8% this year. A Bloomberg survey shows that analysts expect the currency to rise to $1.12 by year-end. Technical charts indicate that the euro entered a fresh bearish trend after closing 0.4% lower on Wednesday.

Unless a coronavirus vaccine comes sooner than anticipated, risks facing the euro are unlikely to dissipate anytime soon and the currency may be facing a one-way road down. The gloom deepens further as the notion of a euro existential crisis resurfaces, with credit-default spreads between Germany and U.S. widening and pointing to a much stronger dollar.

Real money investors have stayed on the sidelines lately after being active for the better part of March and April, according to two traders in Europe who asked not to be identified because they are not authorized to speak publicly.

Risk is now growing that they will need to unwind their long-euro positions given the ECB may need to ease monetary policy more than the Federal Reserve, with euro area governments failing to agree on joint fiscal action.

ECB Vice President Luis de Guindos said that the Governing Council is “more determined than ever” to support the euro-area economy after the deadly coronavirus forced businesses shut and plunged the 19-nation region into its worst recession in decades.

• NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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