Euro Almost Hits 1.1500 as Markets Crash-But Can the Rally Last?

Posted on

Market Drivers Aug 24, 2015

Euro nearly hits 1.1500 as Asian equity markets crushed
All eyes on US as risk aversion flows dominate
Nikkei -4.36% Europe not open yet
Oil $39/bbl
Gold $1157/oz.

Europe and Asia:
No Data

North America:
USD Chicago Fed 08:30

It was a tumultuous open to the start of the week as Asian equity markets crashed once again with Shanghai dropping as low as -9% at one point before recovering to trade at -4%. The Nikkei also lost more than -4% as panic hit investors on fears of a possible global slowdown led by China.

In currency markets the massive waves of risk aversion saw the EUR/USD rise by more than one big figure with the pair just failing at the 1.1500 level during peak selling of Asian equities. Some investors may be puzzled as to why EUR/USD should see such strength amidst such carnage in equities. Typically the pair used to fall during times of risk aversion and rise when stocks rallied.

However, that was during different times under different conditions when the euro enjoyed an interest rate premium to the dollar. Since the near ZIRP conditions of the ECB QE program the euro has actually become the preeminent carry funding currency due to its liquidity and ultra low funding costs.

As several analysts have pointed out, investors have borrowed heavily in euros and used those proceeds for more risky bets in equities. Therefore the massive crash in global indices has caused a huge unwind in the EUR carry trade pushing the single currency higher not only against the dollar but against every major G-10 trading partner.

The short squeeze in the EUR/USD has been so vicious that it has caught many long term investors by surprise. The conventional wisdom on Wall Street assumed that the euro would decline in H2 of this year as the divergence in monetary policies between the Fed and the ECB would make its way felt in the cross. However the events of the past two weeks have completely upended that thesis.

The markets now expect the Fed to remain stationary in September and some analysts are even calling for a rate freeze until 2016. Meanwhile the collapse in equities continues to unwind the euro carry trade pushing the pair higher with each market downleg. Still having now nearly touched the key 1.1500 resistance level the EUR/USD could find further upside much harder going. If equities stage any type of recovery rally the pair could fall as quickly as it rose and drop towards the 1.1250 level from which it broke out last week.

Boris Schlossberg
Managing Director

Leave a Reply

Your email address will not be published. Required fields are marked *