Today we saw a huge overnight gap-fill in Euro that clocked in a massive 5% round-trip in Euro futures. Frankly, I don’t buy this carry-trade unwind explanation. Yes, the mechanics of it make sense, but 5%? Ok, yes SNB was involved, but still. The thesis underpinning the short Euro carry trade is that the Euro falls or Euro rates stay low. Prior to today’s move, the Euro was up ~8.5% since the March lows and Bund yields are up ~1000% or ~100bps. We’re supposed to believe that everyone woke up this morning – NOT anytime prior while the Euro and Euro rates continued to steadily rise, and realized “oh shit, things could get real nasty with Greece stirring the pot. I better cover?” Moreover, the notion that Euro rates are in for a sustainably higher surge or that Greek turmoil will push the Euro sustainably higher while Draghi’s Bazooka has only just been primed, fails to hold water.
We can dissect the idea that the ECB is ready and willing/really wants to unleash Q€2 into three baskets: (1) accelerating German weakness, (2) contagion prevention, and (3) willingness to do “whatever it takes.”
(1) As I discussed last week, we’re seeing a deceleration in German macro data, which is also beginning to spread to the periphery. Tonight we’ll get reads on German Retail sales, which have slowed since March and are expected to stay flat in May. France will release PPI data which first showed weakness last month and consensus expects to see a 0.2% contraction in consumer spending in May. Data in Italy has been relatively flat, as are expectations for CPI and PPI numbers for May. The only positive signs for EU macro data relates to inflation where CPI and Core CPI have been on a tear. We’ll see if recent Euro strength weighs on inflation rates. I expect these data to largely underperform and inflation to decelerate largely because the Euro has moved up too quickly. Cue Q€2 rumours.
(2) We’ve seen peripheral yield spreads over bunds widen since Q€1 was announced with new highs put in today on Grexit fears. As fears intensify, I expect spreads to widen further and Draghi’s hand to be pushed to stir more rumors of expanding, or accelerating Q€ to calm credit markets. We’ve already seen the first of these rumors this afternoon, via Bloomberg;
- ECB’S COEURE SAYS ECB IS EVEN READY TO USE NEW INSTRUMENTS, WITHIN ITS MANDATE
(3) Draghi has among the most credibility of any central banker and when he committed the ECB to doing “whatever it takes,” he made what he believes to be a sacred promise. Draghi is entirely unwilling to allow anything to threaten the EU recovery – fragile as it is, especially not for fear of doing too much Q€.
In short: stay short Euro.