Hedge funds are increasingly bearish on the euro as next week’s ECB meeting approaches. According to Bloomberg, these funds have unwound almost 90% of their net long positions in euros in just one month, due to growing speculation that monetary policymakers will hit the brakes and stop a cycle of aggressive increases. Both economists and markets are divided over the ECB’s next decision, with traders giving only a 40% chance of an additional quarter-point hike next Thursday, September 14.
Although inflation remains high and is well above the ECB’s target of 2%, signs of deterioration in growth are emerging, providing fertile ground for bets against the common currency, which has already ca down almost 5% since mid-July in the longest streak of weekly losses since 2014. “The euro’s weakness is justified; I think the ECB will stop,” said Janet Mui, head of market analysis at RBC Brewin Dolphin in London, adding that it will be a “tight decision.” “If they stop raising rates, the euro could weaken a little more.”
This opinion is becoming more and more common. While the median prediction is for the euro to end the year at $1.09, up from around $1.07 today, a few weeks ago the expectation was $1.12. This is the biggest forecast revision in more than a year. Many industry experts warn of a deeper fall toward parity with the dollar. HSBC Holdings Plc, which was previously bullish with a prediction of $1.15 for the euro, has cut it to $1.03. Capital Economics believes it could reach $1 by the end of the year, a historic level that was last reached in late 2022. Investors are starting to heed these warnings.
“Most hedge funds are bearish on the euro and generally bullish on the dollar,” said Antony Foster, head of G-10 spot currency trading at Nomura International Plc. “Conversations with clients suggest they are concerned about poor survey data that is not picking up, but inflation remains high. They are also concerned about energy prices and China.”
Change of trend in the market
It’s easy to understand why optimism has diminished. The euro zone economy barely grew in the second quarter and the pace of corporate bankruptcies doubled, while the latest reading of activity showed an intensifying contraction. Not too long ago, the market was betting that the United States would enter a recession while Europe could escape it. Now, the situation seems to have taken a 180 degree turn. This has boosted the dollar on all fronts, with the Bloomberg Dollar Index on its longest weekly winning streak since its inception in 2005.
The change in sentiment may not be temporary. Analysis of the position, which takes into account the moving average and volatility of the euro, is indicating a “bearish continuation” signal for the first time in 2023, according to Bank of America Corp. “This suggests that the downward trend in euro/dollar can continue,” defended Athanasios Vamvakidis, head of G-10 currency strategy at the bank. “Eurozone data has consistently surprised negatively in recent months, especially compared to US data. In Germany, the data has been poor.”
For the euro to continue falling, it would first have to break the $1.05 level, a hurdle it has already bounced off of several times this year. Further evidence of this could lead some investors to take profits on their short positions. This makes it a support level that most options traders are betting will hold. The market should also not underestimate the ECB’s determination to combat inflation, warns Grace Peters, head of investment strategy for Europe, the Middle East and Africa at JP Morgan Private Bank. Peters is among the group expecting another rate hike next week that will support the euro.
“I’m more inclined to buy euros at these levels,” Peters told Bloomberg. “It is easy to be bearish on the euro at the moment because of the focus on growth, but the ECB has a single mandate and that is inflation last. This could be the rate hike for this cycle, but the ECB will have to remain tough “The euro has room to appreciate.”
Although the outcome of next week’s meeting may be too uncertain, and opinions on the ECB’s Governing Council are diverging, what is clear is that the euro zone is unlikely to be able to withstand even higher borrowing costs. This gives the dollar an advantage, given the greater strength of the US economy. “I’m not sure Europe’s economies can last much longer,” says Luke Hickmore, chief investment officer at Abrdán Plc. “There is a big risk of stagflation here, which is not good for almost all asset types, including the euro.”