On Friday 18th May, a new record was set. Non-commercial (i.e. people like you and me) FX traders are now sitting on more EUR/USD short positions than at any other time in history.
In the past 2 weeks, an additional 70,000 standard lot contracts have been added to the short tally taking the total open short interest on EUR/USD to a staggering 173,000 contracts.
The good news is that most of these short positions have paid off. The EUR/USD pair has gradually and consistently fallen from 1.3300 down to 1.2650 over the last few weeks.
The bad news is that people who have planned on the EUR/USD progressing linearly downwards to 1.0000 may be in for a substantial wait.
(click to enlarge)
Why The Wait?
Let's play a game. You choose the European country, financial institution, GAA (generally accepted acronym) (examples you could choose: PSI, EFSF, ESM, LTRO, TARGET2) or politically engineered money-guzzler (ECB, IMF) and I will respond with a list of concerns, problems, shortfalls, oversights, and systemic issues. Heck, I'm sure you could probably play this game with yourself by now!
And what do you do when you can play your own game? You look for opportunities to profit from it. Thus, we come back to the historic short positioning in the EUR/USD pair.
The most obvious and accessible way to bet on a Euro fail is to short the Euro… preferably against a 'safe haven' currency like the USD. So if it's such a no-brainer, why hasn't the pair dramatically plunged to the downside?
US Economic Outlook & QE Risk
Let's get something straight. QE3 will happen. There is no doubt in my mind that the Fed will print more and more and more cash through the foreseeable future. I'll soon be writing about the reasons why so stay tuned.
For now just take it as fact that another QE initiative will be launched, either in June or July / August (when the Fed meets).
More QE is USD negative, and USD negative = EUR/USD positive.
Don't underestimate the underlying integration between the EU and US economies either. A horrendous macroeconomic development out of an individual EU country is obviously EU negative, but also US negative. EU demand is intertwined with US supply.
Thus a confluence of negative EU developments (as has occurred recently) also raises the risks of US deterioration which in turn = QE3.
EU Bank Asset Repatriation
Despite upbeat rhetoric from politicians and robot officials, EU banks are largely broke and they know it. If it wasn't for the ECB's generous LTRO scheme, many banks would have been wiped out long ago.
Unfortunately even the ECB requires collateral on lending (it's ok, junk-status collateral will do) which presents banks with a bit of a problem. The've well and truly used up all of their quality collateral and are almost out of junk-status collateral too!
So what to do? Simple: Liquidate any and every remaining asset under the sun, including Gold (did anyone notice the recent slump in the Gold price?) and foreign assets to nominally shore up the balance sheet and keep the bank running for another short while.
After all, outright insolvency or bankruptcy is so not fashionable these days.
Foreign assets are likely denominated in foreign currency, thus upon sale and repatriation the foreign currency is sold versus the Euro and this supports the Euro currency.
Where are most EU bank foreign assets? You guessed it: the US - which adds further support to the EUR/USD pair.
Yes, I'm short the Eurozone and the Euro (I'm primarily short sovereign bonds of the binge spending periphery nations - Spain and Italy). With the Euro however, I've prepared myself for a long wait.
1.0000 near or medium-term? Highly unlikely. By year end I would expect us to have made progress towards 1.1000, notwithstanding any major or unexpected developments out of either the EU or US economies. Bottom line: proceed with patience.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
