EUR Strangled by Option Interest

09/25/2014 9:00 am EST

Focus: CURRENCIES

Though it’s been difficult to get overly-excited about the forex market since the Scottish sovereignty referendum and the fact that the euro seems trapped in a relatively tight trading range, Dean Popplewell of MarketPulse thinks another referendum coming up in November could shake things up for global investors once again.

Since the Scottish sovereignty referendum, it has been difficult to get overly excited about forex, especially with the EUR’s price action confined to a relatively tight trading range. The single unit’s recent moves have been telegraphed, influenced mostly by option-related deals and a few uninspiring purchasing managers’ indexes. European bourses seemed to be taking a breather Wednesday morning, ‘righting the ship’ after two consecutive days of selling. It seems that the global investor may have a new focus: the US-led Syrian airstrikes should keep the punters somewhat cautious as the market struggles for direction on the back of few missed leads from other regions.

Wednesday morning’s focus for investors is Germany, where signs of further economic weakness could make it easier for the European Central Bank (ECB) to move to the quantitative easing (QE) stage of policy easing. The German Ifo business climate index has come in at 104.7, weaker than the 105.7 that was expected, and following the 106.3 August print. It’s the lowest reading in 18 months. The breakdown reveals further weakness in expectations (99.3 versus 101.7 previous) and in current conditions (110.5 versus 111.1 previous). Up to now, the market has been anticipating German gross domestic product to return to growth this quarter after contracting in the second quarter, however, Germany’s latest Ifo results would suggest that a rebound could be relatively tame.

chart
Click to Enlarge

German Data Sends Mixed Signals

The mixed German Ifo data briefly managed to push the 18-member single unit to intra-day highs (€1.2860), before the EUR/GBP ran into a rally resistance. Some speculators have been waiting patiently to sell on upticks; recycling euros to improve their short average cost positions. The euro’s current consolidation seems to be easing the pressure on the “over-short” nature of the market as few individuals appear to be squeezed out of their positions in either direction. Currently, market offers in the €1.2865-75 area are holding the line while bids just ahead of this week’s lows of €1.2825-35 are keeping the market relatively contained.

chart
Click to Enlarge

The steep drop in Germany’s Ifo index certainly supports the case for the ECB to engage in full-scale QE that includes government bond purchases. President Mario Draghi has already indicated that they will buy asset-backed securities and covered bonds, but there has been no mention of public debt. The latest disappointments on EuroZone economic activity (PMIs and Ifo) will only support the ECB’s Governing Council members who want to purchase debt on a broader front. Germany’s 10-year Bund yield is again testing the +1% level amid assorted European data. The EuroZone’s peripheral debt continues to trade mixed, Spanish 10-year bonds are outperforming, while Greek debt continues to underperform. The US 10-year Treasury note is trading slightly weaker following its recent gains ahead of Wednesday morning’s US August new home sales data.

chart
Click to Enlarge

NEXT PAGE: The Potential Event Risk Coming Up

|pagebreak|

Commodity Bucks Lay Low

Commodity currencies, like the AUD and CAD, have been on the back foot of late. Their current prices have been highly influenced by their respective central bank rhetoric and softer commodity prices. Governor Glenn Stevens at the Reserve Bank of Australia seems to have made it his legacy to talk the AUD down at any opportunity. The Aussie’s value ($0.8878) is highly sensitive to its largest trading partner’s domestic successes and woes. Recent data from China has been relatively mixed. Some of the current risk-averse currency trading strategies can be attributed to the recent comments made by China’s Finance Minister Lou Jiwei, who indicated that Beijing would not amend economic policies despite some softening of last month’s economic indicators. From Governor Stephen Poloz’s perspective, the Bank of Canada’s solid ‘neutral’ monetary stance continues to put the loonie (CAD $1.1072) under pressure, aided by weaker commodity prices.

chart
Click to Enlarge

There is a potential event risk coming up for the gold market ($1,223.30) that could benefit both respective currencies, and that is a Swiss referendum scheduled for the end of November. Switzerland will go to the polls to potentially prohibit the Swiss National Bank (SNB) from selling gold and the outcome could have major impacts on the precious metals market.

The referendum will cover three aspects:

  • The SNB stops selling its gold reserves
  • The SNB’s gold held in foreign vaults is repatriated back to Switzerland
  • The SNB holds at least +20% of its assets in gold

If the gold referendum is successful, the SNB would be required to buy approximately +1,500 tons of the yellow metal over a three-year period. That, according to analysts, would equate to about half of the world’s annual production and would eventually filter down to support commodity-sensitive currencies. Though the vote is a couple of months away, the result will be felt by investors worldwide, especially if the yellow metal is outperforming despite a stronger dollar.

chart
Click to Enlarge

By Dean Popplewell, Director of Currency Analysis and Research, MarketPulse

Related Articles on CURRENCIES