DB Boldly Going Where No-One Has Gone Before?

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Boldly Going Where No-One Has Gone Before?

Boldly Going Where No-One Has Gone Before?
The last time the euro was at these levels was back in December 2004, when EUR/USD registered its all-time high of 1.3666. How did the market look back then compared to now?

Positioning/sentiment: Surprisingly, euro positions as measured by the IMM and our own positioning indicator were close to flat in December 2004, as market participants looked to take profit on the more than 10% EUR/USD rally that had already materialised. In contrast, both the DB PI and IMM positions are now pointing to a progressive building in euro longs over the last few weeks. Though these may mean that EUR/USD is more likely to suffer from pullbacks going forward, we would be less concerned of the current size of the position compared to the past. For one thing, the EUR/USD rally remains relatively young, with both our own positions and IMM long as a percentage of open interest around two thirds of the size seen during previous periods of accumulating euro positions. Second, looking at the FX market forecasts for EUR/USD over the next quarter (first chart), these would suggest that EUR strength remains a non-consensus view from here. The risks therefore associated with a one-sided consensus trade would not appear to be apparent yet.

Macro outlook: The key driver of EUR/USD strength in 2004 was a sharp deterioration in the US external balance, central bank reserve diversification and fears of a decline in investor appetite for US assets. In contrast, the US cyclical outlook was much more favourable. Eur-US interest rate differentials had already moved by 200bps in favour of the US, narrowing by an additional 100bps by the end of 2005 (second chart). Ironically, EUR/USD hit an all-time high while the Eurozone was struggling to emerge from stagnation, with US GDP growth outpacing its European counterpart by more than 1% over the following year. This divergence between the macro outlook and the EUR/USD exchange rate was also reflected in expressed discontent on `brutal' euro moves from ECB officials and Eurozone ministers. For now at least, the prospects of the US cyclical outlook appear much less favourable, with the market looking for Europe to grow faster than the US this year and officials sounding more amenable to euro strength.