EURUSD: A Short Term Determinants Analysis

|
Includes: FXE, UDN, UUP
by: iEconomists

In this analysis we will have a look at the short term (i.e. under 1 month) trajectory of the EURUSD, currently standing at around 1.3265.

As most readers are probably aware, there is no universally accepted model on determining the fair value of a currency. As such, we look at what is considered the five short run determinants that affect the future exchange rate. As noted, we will do this for the EURUSD currency pair.

The five short run determinants of a currency, by the reckoning of the likes of Deutsche Bank FX strategists, are the following:

  • Bandwagon Effect
  • Investor Positioning
  • Investor Sentiment
  • Risk Appetite
  • FX Options Market Positioning

We will assess each of these determinants individually, and come to a collective weighted decision on whether the euro looks set for a rise or a drop in the near term based on these.

Bandwagon Effect

This can be described as trend following behavior associated with markets. So let's have a look at what sort of a trend the EURUSD is currently in, by looking at the below daily candlestick graph of the EURUSD.


(Click to enlarge)

Source: MetaTrader4

As can be seen in the graph above, since the start of May the euro has shown significant strength, then given this all back and strengthened again in the last month back to these previous levels. As there is no clear trend, i.e. very up and down (however, some may wish to take the view that we are possibly in the midst of the beginning of an uptrend, we would rather not jump the gun on this just yet), we believe that the bandwagon effect on the price of the EURUSD is NEUTRAL.

Investor Positioning

Investor positioning tells us at what levels investors are currently long or short euros against U.S. dollars. In the case of the currency markets, there is no central exchange to gather such data for the market as a whole, however, the weekly CFCT Commitment of Traders ("COT") report, can prove a useful tool to show investor positioning on euro futures. The below graph shows the net speculator positions in black on EURUSD futures.


(Click to enlarge)

Source: Dukascopy

As can be seen above, the futures market is net short EURUSD. However, the amount is under 50,000 contracts, and quite close to being even at 0, and importantly nowhere near being in overextended positioning, as we can see shorts have been far lower.

Based on the above, we therefore feel it prudent to assess current EURUSD investor positioning to be NEUTRAL on price.

Investor Sentiment

Investor sentiment is fairly self explanatory, and to an extent overlaps investor positioning above. It can be considered what investors or the market as a whole is feeling about the EURUSD.

To assess it we will look at a poll of currency forecasts by expert FX strategy teams around the globe. FXstreet.com provides handy access to a poll of forecasts by these teams, which includes the likes Goldman Sachs, RBS, Deutsche Bank and many others, accounting for a total of 37 projections. Since a lot of market players rely on expert guidance, we think it can have a significant impact on investment sentiment. The latest analysis shows that overall the FX analysts are bearish on the EURUSD, with 1 month estimates placing the price at a general consensus of 1.3101.

Based on the above sentiment provided by the currency forecast polling, we assess the effect of investor sentiment on the EURUSD to be BEARISH.

Risk Appetite

Risk appetite tells us the willingness of investors to take on risk. This affects currency prices in that when we are in a higher risk taking environment, investors are more willing to be long higher risk currencies, and the opposite when in lower risk environments.

The USD is considered a lower risk currency than the euro. As such in times of higher risk appetite we can expect investors to be more willing to be long euro investment and therefore in a lower risk environment to favor U.S. dollars over euros.

Gauging investors' appetite for risk is very difficult. Luckily, investment bank Credit Suisse produces a global risk appetite index and tries with best efforts as can be, to monitor it. Back in May, Credit Suisse had reported that the global appetite for risk had hit "euphoria" levels. It has now reversed lower after being at such levels, and it would be a fair assessment to believe it will move back down to lower levels after peaking so high. Certainly this is an expectation of some analysts.

Based on this we assess risk appetite to be decreasing and therefore the effect of risk appetite on the EURUSD is BEARISH.

FX Options Positioning

The final short term determinant of the EURUSD price is the positioning of FX options. As there is a euro FX options exchange traded market (the same previously described COT report), we can look at current positioning.

The last reported put/call ratio in the COT report for EURUSD was 1.25. Meaning a slightly larger amount of puts on the EURUSD. This is quite a small difference. Couple this with the fact that most options expire worthless, it is hard to generate much information from such a number. We therefore assess the effect of FX option positioning on the EURUSD to be NEUTRAL.

Conclusion

The below table shows a summary of our assessment of the five short run determinants on the price of EURUSD.

As we can see from the above, based on the 5 determinants of short term price movement, the future movement of the EURUSD is neutral with some bearish bias.

As such, speculators should be wary of any significant increases in the EURUSD in the short term and look for the possibility of pull backs on any, and a further decrease on current price (although likely to only be modest unless a significant change in fundamentals occurs).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.