Every client we have met over the last two weeks is asking the same question: will today’s historic ECB meeting be a “sell the fact” event for European risk assets and the euro? Our own view is that it will not and we expect EURUSD to make fresh cycle lows over the next few weeks. Here are 3 reasons why:
1. Positioning not that stretched. We do not believe the underlying euro short is as large as feared. First, the SNB shock last week has likely prompted risk-reduction from many market participants, and anecdotal evidence from our investor meetings suggests that most are running less than 50% of the positions they had in Q4 last year. Second, even if some widely-used metrics point to stretched positioning, the overall size has not changed much since last year: speculative shorts on the IMM are close to unchanged from last November even as EUR/USD has dropped by 7%.
2. Fundamental flows are driving the move. Positioning aside, euro weakness is being driven by large-scale capital outflows not speculators. The most recent data show a continuation of Europe’s record fixed income outflows up to November (our Euroglut thesis), with a large chunk finding refuge in US fixed income assets. Not only that, but the recent bounce in European stock markets has not benefitted the euro either: our high-frequency ETF monitors indicate that the majority of these inflows are being hedged, with assets into the previously booming unhedged sector lingering at the lows.
3. ECB not fully priced and can over-deliver. Consensus for today is that the ECB commits to meeting its 1trillion balance sheet target via a combination of TLTRO, sovereign, ABS and covered bond purchases, in turn implying a ~700bn government bond-buying program. We see three sources of dovish surprises to this baseline. First, the ECB may raise its overall 1trio balance sheet target given the deterioration in the inflation outlook since the number was set last September. Second, even if “intellectual” consensus has moved towards 700bn of bond buys, European short-end yields are still not consistent with this level of liquidity injection into the system and can move lower. Finally, Draghi’s forward-looking language will be just as important: an aggressive commitment to do more can allow the market to expect more irrespective of the initial headline.
http://www.mediafire.com/view/21gklw13wbf532n/fx_daily_(1).pdf
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