Traders, Strategists Divided Most in 13 Months on Euro Gain

By Emma Charlton and Lukanyo Mnyanda - Sep 4, 2012 11:38 AM GMT+0800

With the euro facing one of the most pivotal months in its 13-year history, traders and strategists are more divided than at any time since 2011 over whether officials will be able to keep the currency from tumbling.
At about $1.26, the 17-nation euro is 3.3 percent above the $1.22 median year-end estimate of more than 50 analysts compiled by Bloomberg, after the gap expanded to 3.8 percent last week. The last time the euro exceeded the consensus by that much was in July 2011, and it tumbled 9.4 percent in the next 10 weeks.

While traders are optimistic that European Central Bank President Mario Draghi will bolster confidence in the euro with his plan to buy bonds of Spain and Italy, analysts said those same measures are more likely to debase the currency. After the ECB meets this week, Germany’s Constitutional Court will rule on the legality of a bailout fund, Greece’s institutional creditors will decide if the country merits access to aid that would help it stay in the European Union, and Dutch citizens get to vote on parties including a group that wants exit the bloc.

“The ECB’s approach is obviously an easing approach,” Hans Redeker, the London-based head of currency strategy at Morgan Stanley, said in a telephone interview on Aug. 28. “The central bank is printing money and increasing the supply of euros, and this implies that the currency will stay weak.”

Rising Euro

Redeker said the euro will probably drop 5.6 percent to $1.19 by year-end. An advance to between $1.27 and $1.30 would provide a good level at which to sell, he said.
The euro rose 0.2 percent to $1.2619 at 12:21 p.m. Tokyo time today from Aug. 31, when it reached $1.2638, the strongest level since July 2. It climbed 0.4 percent to 98.89 yen. Against a basket of developed market peers, Europe’s shared currency appreciated 0.5 percent last week, according to Bloomberg Correlation-Weighted Indexes, bringing the monthly gain for August to 1 percent, its first advance since March.
Not since July 26, 2011, when the gap was 5.6 U.S. cents, has the euro exceeded year-end 2012 estimates by as much as it did on Aug. 28. The currency declined from a close at $1.4511 that day to a low of $1.3146 on Oct 4. As recently as Aug. 2, traders were more bearish than strategists.
“The longer-term forces acting on the euro still suggest it is probably going to remain an underperformer,” Nick Bennenbroek, head of currency strategy at Wells Fargo & Co. in New York, said in a telephone interview on Aug. 29. “We are still looking at a euro-zone economy that is in recession, compared with the U.S., which is growing slowly.”

Diverging Economies

The euro may climb to as high as $1.30 in late October as Draghi’s bond-purchase program stabilizes Europe’s financial markets, and then depreciate to $1.20 in a year as investors focus more on the economic underperformance relative to the U.S. and the need for more economic stimulus to boost growth, said Bennenbroek, whose firm was the most-accurate forecaster in a Bloomberg Rankings survey for the six quarters through June.
Gross domestic product in the U.S. is forecast to grow 2.2 percent this year, according to the median of 79 estimates compiled by Bloomberg. The euro-area will contract 0.4 percent, a separate set of forecasts shows.

Draghi gave the currency a boost on July 26 when he said he would do “whatever it takes” to preserve the monetary union. He backed that up on Aug. 2, saying that the central bank may buy short-maturity notes issued by euro-area nations, as long as the region’s bailout fund makes purchases directly from the countries’ treasuries and ties the aid to conditions.
Spanish two-year note yields tumbled to 3.51 percent yesterday from a euro-era high of 7.15 percent on July 25. Similar-maturity Italian debt yields sank to 2.63 percent from 5.26 percent.

‘Heavily Oversold’

“Before Draghi mentioned these measures, the euro was heavily oversold,” or below fair value, said Dirk Aufderheide, who helps oversee $350 billion as head of currencies for DWS Investment GmbH in Frankfurt, according to data on the company’s website. “We are expecting a package of decisions, and that should lead to a reduction of the euro-region break-up premium and some further appreciation,” he said in a telephone interview on Aug. 30.

In that case, Europe’s currency may appreciate to $1.28, he said, and it may fall to around $1.20 if Draghi takes no action.
Pressure on central bankers and lawmakers to come up with a long-term solution to the sovereign debt crisis is rising. While the euro is 4.2 percent above the $1.2089 average since its January 1999 inception, it fell to record lows against the Australian, Canadian and New Zealand dollars in August.

Most Bullish

“Draghi has committed the ECB to doing what’s necessary to stop the euro from breaking up,” Daragh Maher, a currency strategist at HSBC Holdings Plc in London, said in an Aug. 29 interview. “Once you begin to reduce the probability of a break-up scenario, then all the efforts become euro positive.”
The euro will rise to $1.35 by the end of the year and $1.37 by March 31, Maher predicts, making HSBC the most bullish of the strategists surveyed by Bloomberg. Current levels “are a buying opportunity,” he said.
Europe’s financial-market turmoil began in 2009 after Greece reported a budget deficit more than previously published, before later negotiating two bailouts from the euro zone and international creditors. Ireland and Portugal also required aid.
Draghi may give details of the latest plan to calm the regional debt woes at the central bank’s meeting in two days, or after Germany’s Constitutional Court rules on the legality of Europe’s permanent bailout fund on Sept. 12.

Breakup Odds

That day, the Netherlands holds elections. Voters will decide among parties including the Socialists, who oppose spending cuts, and the Freedom Party, which is seeking an exit from the EU. Also, Greece is negotiating for more-lenient terms for its 240 billion-euro ($303 billion) bailout with the ECB, European Commission, and the International Monetary Fund.
While German Chancellor Angela Merkel approves of the ECB bond-buying program, it has been criticized by Bundesbank President Jens Weidmann, who was quoted in Der Spiegel magazine as saying the plan may increase governments’ reliance on such funding and won’t help solve the debt crisis.

ECB council members will have about 24 hours to digest Draghi’s proposal before they start debating it, three central bank officials said on Aug. 31. Draghi told lawmakers yesterday he’d be comfortable buying debt with maturities of up to about three years and that it wouldn’t constitute state financing, said Jean-Paul Gauzes, a member of the European Parliament.
Odds on a euro breakup by the end of 2013 rose to 54 percent last week from this year’s low of 35 percent in April, according to Dublin-based Intrade.com data.

Hedging Bets

“We don’t expect the ECB to answer the expectations at this meeting,” David Woo, the global head of rates and currencies at Bank of America Merrill Lynch in New York, said in a telephone interview on Aug. 28. “There’s not going to be that much clarity, which will be a disappointment for the market.”
Woo forecasts Europe’s shared currency will weaken to $1.15 by the end of the year, among the most-bearish predictions.
Even as they bid up the euro relative to strategists’ forecasts, traders are hedging their bets.
Futures contracts that the euro will fall against the dollar have exceeded those betting on a gain every week since August 2011, figures from the Washington-based Commodity Futures Trading Commission show. The difference in the number of wagers by hedge funds and other large speculators on a decline in the currency compared with those on a gain was 101,561 on Aug. 28.

‘Weak Euro’

European exporters are benefiting from a lower euro. Merck KGaA (MRK), the German drug and chemical maker, said Aug. 14 that the decline helped boost second-quarter revenue, which rose 12 percent and beat analysts’ forecasts. Stuttgart, Germany-based Daimler AG (DAI), the world’s third-largest maker of luxury vehicles, reported a 10 percent gain in second-quarter sales, helped by the exchange rate.
Unlike the U.S. Federal Reserve, the ECB has offset its 220 billion euros of acquisitions by taking the cash back as deposits to avoid stoking inflation.

Since the Fed began its unprecedented asset purchase programs in December 2008, IntercontinentalExchange Inc.’s U.S. Dollar Index (DXY), which tracks the greenback against the currencies of six U.S. trading partners, has fallen more than 6 percent.

“There’s likely to be a short-term positive reaction, and then we’ll return to a weak euro on the weak European growth story,” Mark Farrington, who oversees $9 billion as head of currencies at Macro Currency Group, a unit of Principal Global Investors Europe Ltd., said in an Aug. 20 interview. He confirmed the comments yesterday. “If the ECB adopts a more traditional policy response, cutting rates or expanding its balance sheet aggressively to save the euro from a breakup, then we will have a much weaker euro.”


To contact the reporters on this story: Emma Charlton in London at echarlton1@bloomberg.net; Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net
To contact the editor responsible for this story: Paul Dobson at pdobson2@bloomberg.net