Her Eleftherias Kourtalis
Short positions in the euro are recommended to investors by HSBC and JP Morgan, assessing which upward movement is an opportunity to build bearish “bets”, given the many and significant challenges facing the eurozone economy, with fears of a recession hitting already the door of the area.
EUR/USD will retest recent lows below absolute parity in the coming weeks, reflecting the view of HSBC for a generally stronger dollar, as well as headwinds, especially for the euro. The market has already digested the outcome of July’s ECB meeting, where policymakers hiked interest rates by 50 basis points and unveiled their new tool to prevent fragmentation.
Apart from the repricing of interest rate expectations, the July meeting suggests that the expected pace of tightening has accelerated, but it is not clear that this will be enough to continue to support the euro, as the Bank of England estimates.
Ultimately, a 50 basis point hike in interest rates is not a significant step given the pace other central banks are following, HSBC notes.
In addition, the market has already priced in another 200 bp of tightening before the end of the year, which is not expected to be exceeded after the initial 50 bp step. Also, the transmission mechanism between interest rates and the foreign exchange market is becoming more ambiguous as concerns about economic activity intensify.
All of this creates an ambiguity for a currency like the euro that can somewhat capitalize on higher interest rates, but also succumb to recession fears.
“These economic challenges support our bearish view on the euro in both the short and medium term. We now estimate that its exchange rate against the dollar will decline to 0.95 in the coming quarters,” HSBC notes.
More directly, he believes that after the ECB meeting, any upward movement in the exchange rate provides an attractive level for the critical short positions in the common currency. The eurozone is facing a difficult growth/inflation mix, forcing policymakers to tread carefully on interest rates even as inflation is at historic highs.
The July inflation data that will be announced tomorrow Friday will, according to the British bank, be the key to the outcome of the ECB meeting in September.
On this data, it is unlikely that there will be any relief for consumers who are facing a sharp squeeze on their real incomes, as reflected in the low readings for consumer confidence. The risks are intense and the main one is the risk to energy supplies in the coming months, with big questions still looming over the implementation of an energy bill in the EU.
Economists at HSBC estimate that a prolonged period of low or zero natural gas flows could reduce euro zone GDP growth by 2.5%, mainly in the fourth quarter of 2022 and the first quarter of 2023. As the exchange rate is more determined from the growth of the economy despite interest rates, this is a significant risk for the euro.
Another key risk is fragmentation. The ECB appears to have given enough details about the anti-fragmentation tool to calm the market for now and hopes that the mere threat of the tool’s existence alone will ensure that it does not need to be activated.
However, the fact that policymakers even have to consider fragmentation is a significant risk for the euro, HSBC notes. Thus, he estimates that the euro has a lot of room for further weakening before it finds itself in undervalued territory.
Short on the euro, long on the dollar
Short positions in the euro are also recommended by JP Morgan as he estimates that its parity with the dollar will be at 0.95 by September, while in the event of a complete interruption of Russian natural gas flows, the euro will plunge to 0.90 dollars.
Thus, he maintains long positions in the US dollar and the treads he proposes are short in the euro/dollar and euro/Swiss franc exchange rates and long in the dollar against all G10 currencies.
According to JP Morgan, the aggressive stance of the ECB and the existence of the new TPI tool do not reduce the problem of energy dependence which remains the most important risk for the eurozone and the common currency, at a time when early elections in Italy also increase the risks for the euro.
The impact of tight natural gas flows, he said, was already visible in PMI indicators, which fell below 50 for the first time in 18 months, further increasing the chances of a recession in the region as well. And the ECB’s front-loading tightening is not enough to offset the big risk for the euro, which is the energy supply issue.
Source: Capital
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