EUR Contained While GBP Has Potential

Includes: FXB, FXE
by: Dean Popplewell

By Dean Popplewell

Looking at euro policy makers, from a market and credibility perspective, they are playing with fire by using strong words to talk about action in June. The biggest risk to the market is the ECB disappointing at the next rate decision meeting on June 5th as it has done in the past. If so, all the hard work done by the EUR bear over the past 10 days would immediately be unwound, allowing the 18-member currency to bounce back towards the heavily defended and psychological €1.4000 print. The current price action since the single-currency's fall from grace after the ECB meeting could be ending.

To many, ECB action seems certain but what's to be delivered remains unclear. Euro policy makers will have to deliver a compelling initiative, enough to ensure financial markets react positively and weaken the EUR. A -10/15 bp cut in key rates, a negative deposit rate and or leaving the SMP unsterilized are some examples of what's possible. Many expect that slashing deposit rates could have the biggest impact on weakening the EUR, especially against USD and GBP –now that the FED and BoE are expected to hike next year.

Large EUR outright moves are not common in this low rate environment. The current suppressed "option" volatilities would suggest that the most recent of declines could be a "one-off." The EUR's rally from €1.3648 to €1.3732 coupled with the accompanying dip in US yields have certainly surprised a large percentage of the market. So far, this squeeze has not broken any technical levels, allowing investors to continue to try and pick tops. Obviously, the longer the price action congregates at or near current levels (€1.3725), it will begin to make the EUR bear that bit more nervous. Yesterday's larger buyers – mostly reserve managers – have an end use for the currency. Today's short positions are predominately being held by speculators. The EUR's recent rise, especially ahead of the weekend, could lead to further EUR support and more profit taking. However, from a technical perspective it would probably take a solid move above €1.3810 to damage any EUR bear's hopes. For now, the single currency's bottom may be in, while the top's progress could be confined to €1.3800 region at least until next month's ECB meet.

For now, the pound looks to be the best buy of a bad bunch, at least until the "long" trade has become "overcrowded" again. This was certainly in evidence when the cable broke through the £1.7000 handle. Once through, many spec positions began to talk €1.74 to £1.8000. However, the bull run fell apart on the back of the EUR outright decline. Recent GBP selling has been led mostly by the EUR being dumped. With the spec long position now somewhat reduced, the rate differential viewpoint certainly supports buying sterling on dips. For now, the 55-DMA and last month's low (£1.6723) continues to support the pound.

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