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There are predominantly three factors we would cite as having helped EUR cope with the region’s limp economy thus far:
1) The currency is structurally undervalued, meaning there is already a decent risk premium for the chronic underperformance of the economy. The EUR REER is 5.6% below its 20Y average whereas USD is 4.5% expensive.
2) Despite the economic slowdown in 2018 the ECB still terminated QE last year and for good measure was prepared until only very recently to begin to normalize interest rate policy. Consequently, there has been little real pass-through from a weaker economy to monetary policy and hence to the exchange rate.
3) The Euro area may have mediocre growth but it has the strongest underlying balance of payments position in G3. Last year this BoP support was supplemented by relative aggressive central bank flows from USD into EUR.
We estimate that central bank reserve diversification added 1.25% of EUR demand to the 3.3% of GDP accounted for by the region’s basic balance surplus (the current account together with net equity and FDI flows). This structural demand for EUR sets quite a high bar for the currency to depreciate.
The JPM’s EUR forecasts have long recognized and attempted to balance the innate tension between favorable structural factors such as valuation, the BoP position, and more adverse cyclical conditions. For much of the past year, the compromise has been to emphasize the cyclical drag in bearish short-term forecasts and trade recommendations (we are currently short EUR vs CHF & JPY), while overweighting the structural drivers including BoP and valuation in a modestly positive trajectory for the medium-term EUR forecasts.
EURUSD trade tips: At spot reference: 1.1144 levels, contemplating the above factors, one can execute boundary options strategy. Such exotic option with upper strikes at 1.1184 and lower strikes at 1.1101 (the recent lows) likely to fetch exponential yields than the spot moves.
Alternatively, shorting futures of mid-month tenors have been advocated with a view of arresting further potential slumps, we now wish to uphold the same strategy. Writers in a futures contract are expected to maintain margins in order to open and maintain a short futures position. Courtesy: JPM
