DB FX Daily: Update on EUR/USD Drivers, Ex-Ante Risk Adjusted Carry

[RTFX-Trading]

FX Daily: Update on EUR/USD Drivers, Ex-Ante Risk Adjusted Carry

EUR-USD Spread Trends Resume with Positions Now Pared Back

Earlier this week, we noted that short USD positions had been trimmed but that further consolidation of the EUR/USD rally around 1.36 was likely. This outlook for further consolidation rested mostly on cyclical factors such as spreads as we observed that weak US data seemed to be having a diminishing impact on US rates and likewise strong Eurozone data on European rates leading to a stall in the spread trends which had helped to drive EUR/USD appreciation. But following several days of spreads drifting sideways, both nominal 2Y and 10Y real spreads (see chart at left below) pushed back to the tightest levels seen in this cycle during yesterday's trading. This came about despite a stronger ISM manufacturing index on Tuesday and a softer PMI reading in Euroland yesterday. If the spread trend is indeed still intact then tomorrow's payrolls release may offer the prospect of breaking away from this recent consolidation around 1.36. In the DB FX Theme Radar released separately this morning, we note that monetary policy as measured by the change in rates is still the main driver of FX thus leaning against a resumption of the spread trend may still be difficult. In addition, FX reserve numbers published on a weekly basis by some large EM central banks continue to show steady accumulation of assets (even if below the recent peaks) which may still present a supply of USD to the market in the event of stronger US data and a dip to 1.3550 and slightly below. Taking the positioning, spread and reserve information together we believe there is not yet enough evidence pointing to a turn in the grinding rally in EUR/USD which remains the base case. The one caution may be in the short-term reactions to recent data. Though the spread trend may be intact, the speed of the USD rally following the ISM number was much larger than the USD sell-offs following softer data such as GDP, PCE and ADP. Thus on stronger US data, the test of the trend may come towards the bottom of the recent range between 1.3520-50 as it may provide a test of whether a structural supply of USD from central banks is relevant to the current weak USD trend or if it has softened with higher levels in EUR/USD.