- Hedge funds have turned bearish on the euro, but only recently. Meanwhile, asset managers have pared net longs, though these remain historically large.
- We think positions can continue to trend more bearish, with the euro likely to weaken further. CME Group data on option strikes suggests a possible return to parity, with strong demand for put options until at least 1.03.
- The FX volatility curve using CME Group options data suggests investors are in “calm” mode.
Having traded below parity last year, the euro had been recovering through most of 2023. However, dynamics have changed: It is down over 5% in H2 and now negative on the year. European growth has lagged that of the U.S., helping markets reprice expectations for both the European Central Bank and Federal Reserve – unfavourably for the euro. In the same period, crude oil has rallied. With Europe a net importer of energy and the U.S. a net exporter, the euro found another reason to tumble.
This poor backdrop has led hedge funds to alter their positions: They closed 24.8k long positions and opened an additional 5.5k short positions over the past month (Chart one). Hedge funds sit net short on the euro by 23.3k futures contracts. No other currency has seen a larger bearish revision over the period.
Asset managers have followed a similar path, bearishly revising only pound positions more than euro ones over the period. However, they remain in a historically large euro net-long position (359k). The Mexican peso is the only currency close to having as large asset manager net positioning (122k).
Aggregating investor positions, we find hedge funds and asset managers are both net short the yen and the Australian, New Zealand, and Canadian dollars. They disagree everywhere else, including on the euro.
Macro Hive take: we are pessimistic on the euro. Rebounds in the euro have come amid a rebound in hedge fund net positioning, which has only just turned net short. Meanwhile, the U.S. has much stronger growth than Europe, with few signs of convergence. The U.S. dollar has a positive carry story over the euro, which we expect to continue through 2024. High oil prices are a positive for the dollar. And U.S. investors are reluctant to buy foreign bonds, which had previously weighed on the U.S. dollar. Therefore, we think the euro may well continue to underperform the U.S. dollar, with another visit to parity possible.
Option strikes
The euro is trading towards year lows. To weaken further, it must remain below bullish option strikes. According to CME Group data on option strikes:
- There is notable net demand for EUR/USD puts from 1.07 until 1.03 (Chart three). This means investors need EUR/USD to trade below at least those levels to register a return on their put options.
- Bullish demand is more persistent, however, present from 1.10 to 1.20. Demand falters thereafter.
What to watch: The direction of the euro remains reliant on growth and central bank outturns. Consequently, key U.S. and European data will continue to make headlines and drive the pair. Focus will be on U.S. non-farm payrolls (6 October) and inflation details in both (Europe: 29 September; U.S.: 12 October).
FX investor risk appetite
CME Group has a range of FX volatility data to help investors track the level of volatility. We can also use FX volatility data to determine investor risk appetite. We find the shape of the FX volatility curve useful in this regard. When shorter-dated FX implied volatility is higher than longer-dated volatility, this suggests investors are worried or in panic mode. In contrast, when shorter-dated FX volatility is lower than longer-dated volatility, this suggests investors expect calm markets. The latest data finds:
The FX volatility curve is flattening back towards years lows, having been in a steep curve only momentarily (Chart four). This suggests investors are becoming surer that a soft landing is possible and are calmer.
The move aligns with the CME Group CVOL volatility indices, which have followed a similar dynamic, rising from lows in June.
Outside FX, equity volatility has bounced from historically low levels, while rates volatility remains historically elevated despite being pared to 2022 lows.
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