Euro defies gravity

The rally in the euro seen in the last three weeks has exceeded most traders’, even the rare euro bull’s, wildest imaginations.

Now, as the market digests the sell-off in German Bunds and European stocks, such as the DAX, and the ensuing unwinds of euro shorts put on as hedges, even die-hard euro bears were starting to pencil in a higher euro in the near-term.

The euro was trading at $1.1357 Wednesday, on the high side of the day’s range of $1.1185 to $1.1368. The earlier high was the highest level seen since February 26, when the pair topped out at $1.1380, seen as initial resistance.

Given last week’s decisive break over $1.1052, the March 26 high, market players saw the euro as moving into a $1.1000 to $1.1500 in coming sessions, with scope for a possible overshoot to the topside.

“Last week we noted the upside movement in EUR/USD and the likelihood that reduced USD exposure would bring some selling of U.S. fixed income, particularly Treasuries, a market in which some investors likely took exposure simply to get exposure to the rising USD,” said Bob Sinche, global strategist at Amherst Pierpont Securities.

Amherst Pierpont has been arguing for the euro to move back into a new $1.1000 to $1.1500 trading range, he noted.

Earlier, the euro vaulted its 100-day moving average, currently at $1.1259, as well as $1.1292, the 23.6% Fibonacci retracement of the decline from the May 8, 2014 highs near $1.3993 and the March 16 lows near $1.0458. Wednesday’s decisive break above $1.1292 suggested scope for a move to the 38.2% Fibonacci retracement, which comes in at $1.1808.

“We would view a rise to the $1.18 level a short-covering overshoot and a level at which to re-sell EUR/USD,” Sinche said.

On the day, with German Bunds and the DAX seeing renewed selling earlier, there was newfound demand for the euro as FX hedges were unwound.

The euro tripped off stops in the $1.1290-$1.1300 area, with extension to the day’s highs near $1.1368. With the pair maintaining a toehold over $1.1300 in afternoon action, traders looked for the test of the February 25 and Febuary 26 highs at $1.1389 and $1.1380 respectively, which if broken would target at test of the Febuary 19 peaks near $1.1450 and then the psychological $1.1500 mark.

While bullish in the near-term, bigger picture players were looking at entry levels for a euro short position.

We came down so quickly,” observed one U.S. trader, noting the euro’s 25.3% decline from $1.3993 a year ago to the mid-March lows near $1.0458.

The sub $1.1000 levels seen in March and April were likely a temporary overshoot, driven by expectations of what European Central Bank QE would do to eurozone yields.

More recently, as German Bund and other eurozone yields have moved higher, traders have rethought their euro view.

Analysts warned to keep an eye on both U.S. Treasury and German Bund yields as well as European stocks.

Ten-year U.S. Treasury yields held at 2.242% Wednesday afternoon, up from the 1.896% low seen April 27, as well as the 1.809% low seen April 3.

Ten-year yields were within striking distance of 2.2575%, the high yield seen March 6, in the wake of a 295,000 increase in February U.S. non-farm payrolls. If 2.26% gives way, the focus will be on 2.347%, the high yield seen December 8, the Monday after another upbeat U.S. non-farm payroll release.

Ten-year German Bund yields last traded at 0.584%, down from an earlier high of 0.5977% and well over ten times higher than the 0.0485% record low yield seen April 17.

The German DAX closed up 0.2% at 11,350.15 Wednesday. At the close, the DAX was down 8.4% from the life-time high of 12,390.75, seen April 10, and up 15.8% year-to-date.

“With bonds, QE in the U.S., UK and Japan drove rallies pre-announcement and either range-trading or sell-offs afterwards,” said strategists at JP Morgan.

In terms of FX effect, “currencies tended to decline into QE announcement and recover or consolidate thereafter,” they said.

In the first quarter of 2015, ECB QE looked to be “unfolding unlike the Fed, BOE and BOJ programs,” the strategists said.

“Rather than consolidate or turn higher in late January once the ECB announced its program, German Bund yields and the euro continued to decline, prompting rather breathless claims about how different the ECB’s program would be because of such low net bond issuance in the Euro area,” they said.

While ECB QE “was the most aggressive in history when measured by aggregate purchases relative to supply,” at the same time QE was  “coming during an upswing in the business cycle, and belatedly, when Bunds looked extraordinarily overvalued and EUR/USD historically undervalued on our preferred models,” the strategists explained.

“So strategy since QE announcement was less aggressive than the issuance story might normally suggest, simply because fixed income and FX valuations were terrible,” they said.

JP Morgan warned that further unwinds may be seen before the dust settles and fundamentals can be traded again.

“ECB QE has further to run and its dampening effects on rates, volatility and the currency will reassert themselves eventually, but those aren’t the trades to have on at this stage of the QE cycle,” the strategists said.

In the near-term, the euro will take its cue from overall dollar direction as market’s react to Friday’s release of U.S. non-farm payrolls.

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