Weakening euro set to make convincing foray at parity against dollar

Following a failed attempt at parity earlier this year, the euro may be set to make a more convincing foray at parity to the US dollar.

Weakening euro set to make convincing foray at parity against dollar

That is because a crucial driver for further weakness in the common currency is now on a substantially different path to that of the dollar.

One key difference this time is that the euro is facing downside pressure from investors both going short on the euro and building long dollar positions.

The pair has finally broken the $1.08 level for the first time since late April and threatens support at $1.066 as it did back in late May, in a pattern that looks strikingly similar.

Strong support is now seen near $1.05 where barriers may have been placed ahead of a year-to-date low at $1.0458.

The euro has seen a sharp fall against the dollar within a short period of time, reaching similar oversold levels on technical indicators.

Risk reversals, a gauge of market positioning and sentiment, are close to May levels, especially in the front end, signalling that traders assign similar probabilities on trend continuation.

What is different this time is that the ECB recently stepped up its rhetoric to further ease monetary policy.

That is quite a turnaround from just a few months ago when talk was that the Governing Council may end its quantitative easing programme sooner than expected.

The ECB’s initial monetary stimulus was already priced in the currency’s drop to the $1.0458 mid-March low, leaving the market to trade the dollar side of the equation thereafter.

Moreover, the Fed now seems less troubled than before by the broader dollar strength and the effect of international shocks on its economy.

Last Friday’s off-the-charts payroll numbers further reinforce this sentiment.

An actual Fed lift-off will confirm further widening of monetary policy divergence and spur real money and other long- term investors such as pension funds, asset managers, and insurance companies to re-engage in the short euro-dollar trade, thus taking the euro to fresh year-to-date lows.

Chances of the Federal Reserve Funds rate being within the 1% to 1.25% band at the December 2016 meeting are being priced at 21.7% compared with 24.1% in late May.

Four traders in London and one in southern Europe, who asked not to be named, say real money investors have recently sold the euro mainly against emerging market currencies and not against the dollar, sterling, and the Swiss franc.

A key risk to continued euro weakness is that the ECB refrains from further easing policy at its December meeting due to the recent decline in the euro.

Vassilis Karamanis is a strategist who writes for Bloomberg. The observations he makes are his own

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