The euro is one of the most traded currencies in the world. Per the European Commission, the euro's share of international payments is about 36%, and represents about 20% of foreign exchange reserve holdings. While the yield on the euro is in fact negative against so-called risk-on currencies like the U.S. dollar, Canadian dollar and Australian dollar (see chart below), the euro can be viewed as a "risk-on" currency itself.
(Chart created by the author using TradingView.com charting tools. The same applies to all subsequent charts presented herein unless otherwise specified.)
In the chart above, I am plotting (using daily candlesticks) the euro currency index, which conventionally maps the euro's strength against the U.S. dollar, British pound, Japanese yen and Swiss franc. Further, the lines on the chart are as follows:
- The (top) yellow line represents the spread between the Italian one-year government bond and the Australian one-year government bond.
- The (middle) blue line represents the spread between the French one-year government bond and the Canadian one-year government bond.
- The (bottom) orange line represents the spread between the German one-year government bond and the U.S. one-year government bond.
The spreads of the above are plotted on the far-right y-axis, and as you can see, they are all negative (-1.02%, -2.25% and -2.62%, respectively). I have used a mix, as Europe being a large place deserves a holistic view. My selections are arbitrary and not at all contrived. The yields on these European nations' bonds serve as a holistic proxy of the short-term international yield of the euro.
And indeed, if we go to an updated table (offered by Forexop.com) that tells us the current spread offered by some popular Forex brokers, the euro can be confirmed as a negative-carry trade:
As you can see, some of the best carry trades here involve shorting (selling) the euro. This naturally places great pressure on the euro.
The issue most recently is that the spreads are narrowing. As you can see in my first chart, the spreads have lifted. This makes shorting the euro less attractive, in theory. Yet, the negative spreads offered on euro trades still remain deeply negative. And the ECB's monetary policy tone is once again sounding expansionary. In fact, it is thought the ECB will in fact ease rates first before considering further quantitative easing.
In other words, if anything, the spreads are likely to worsen going forward. At best, they will remain about as negative as they are now. While other central banks like the U.S. Fed are expected to ease too, long-term inflation expectations for the euro zone are especially poor, in the region of just 1%. As a result, I see the price of the euro remaining under strong fundamental pressure from a Forex standpoint (long term, not just on a short-term basis).
The Japanese yen remains an important barometer of risk-off pressure: the stronger the yen, the greater the flows out of so-called positive-carry trades (in which you buy one positive-yielding currency in terms of a negative-yielding currency). The yen is a negative-yield currency too, like the euro, yet when it is bid up, market sentiment can be viewed as bearish, or "risk-off".
Given the political and economic risks of the euro zone (e.g. the European debt crisis), the euro is actually seen as a risk-on currency despite its negative yield. The yen is viewed as being less risky, and as such, foreign repatriation and conversions of currencies back into yen is seen as risk-off activity.
The EUR/JPY pair has recently been bid up, signalling risk-on activity. The chart below demonstrates this, comparing the move with S&P 500 futures.
As you can see, the two are fairly positively correlated. However, a more detailed look at the EUR/JPY pair puts the recent move up into question. The chart below is a four-hour candlestick chart, which offers a more granular perspective on price action.
Price Action and Fibonacci
The chart uses a Fibonacci analysis mapped against the opening price of 20 June 2019 of 121.702 and closing price of 21 June 2019 of 120.968 as pinpoints. I have added a line to extend the 423.60% retracement level at the top to identify historical context (notice it matches almost perfectly with the May low (see top-left of chart).
Further, the other retracement levels (361.80%, 261.80% and 161.80%; black, red, blue, respectively) all match up with recent highs and lows (which can be viewed as key levels). I have also added a small black line at 121.992, which matches up with the recent closing price of this week.
Personally, I interpret this price action as controlled selling. No flash crashes, but the moves are overwhelmingly bearish. Retracements are expected (fractally, on all time frames). Yet, the euro is is ultimately signalling "risk-off". The hourly candlestick chart zooms into recent price action to show further how EUR/JPY appears to have merely targeted equal highs before returning downward.
And for good measure, the chart below maps the pair against the yield on the German ten-year government bond.
In summary, I see here a short-term upside retracement offering strong potential to short the euro against the yen (and possibly other positive-yield currencies like the U.S. dollar) to exploit the long-term fundamental headwinds that the euro must face into the future. The pair may rise further at first, into next week, but any rises are likely to be faded by the market.
And yes, this would put into further question the recent rise (and positive, risk-on sentiment) in U.S. equities. But that's another discussion.
Disclosure: I/we 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.