Right now I still think currencies are the best way to make a leveraged trade, so my focus is on the dollar, relative to EUR, with GBP (election jitters?), JPY (net positioning is even) and AUD (downgrade?) in the corner of my eye. I think US equities will peak this year, possibly this summer (and Chinese equities at some point soon will bubble-peak), at least for the foreseeable future, but I'll cross that bridge when I come to it. Before I go in to analysis, I think its important to remind myself that whatever trade I make must not be over-leveraged; I don't want to be spooked or forced out of a position. The time to make a homerun swing at the dollar was last summer, which I didn't spend enough time focusing on, and made overleveraged bets that I was too scared to lose gains from. Short AUD looks interesting, especially since
Goldman suggests they may be downgraded within months, but I think China will continue to ease monetary policy. I only have the capability to pursue one opportunity at a time, and I think the better one is EUR/USD.
EUR/USD is my main focus because it offers action and I think the market has a tendency to exaggerate, which provides opportunities. The bounce off the lows seems to be in part: 1) short covering, 2) weaker US economy, 3) improved Euro fundamentals, 4) hope that Greece will be solved without a mess, and 5) small reversal of bond yields. I want to explore each in detail:
1) Short Covering
Net EUR/USD short positions are hovering near record levels, which gives me the greatest pause for jumping on board the bandwagon. On the one hand, I tend to see herd behavior and extremes as a signal that things are about to turn, and turn fast. On the other hand, the last few years has shown that the herd can run for a while before that happens, and EUR/USD shorts have been extreme for a while and have continued to make money because EUR had been so strong (and $ weak) for so long.
Speculative net shorts are also at extremes but are moving fast in the other direction:
Leveraged money also remains very short, but as a smaller percent of outstanding contracts...
2) Weaker US economy
It doesn't even seem worth doing more than mentioning that the US economy has struggled in 2015, from a higher dollar and dislocation from lower oil prices and the market wringing its hands over the impending rise in FFR. These have, and will continue, to effect employment. But the weather is warming (psychological effects), oil is firming, the dollar is weakening, so Q2 looks set to be mediocre (large inventory buildup to work through). I think it will be enough to have a rate rise by September. I still think June is on the table, though, as I think the Fed really wants to get off ZIRP.
3) Improving Euro fundamentals
Loans to the private sector have finally started moving up, as has credit growth in total:
M3 has resumed growth:
Inflation has stabilized, and with oil prices increasing, will likely increase as the year goes on:
Unemployment is moving in the right direction:
PMI's and IP showing stability, at least:
And the current account surplus has grown, thanks to an improving balance of trade:
All in all, the economy is (very) slowly improving and that looks set to continue for a bit longer.
4) Greece
Here (combined with 5) is where I think the biggest prospect for more EUR weakness lies. Greece seems intent on dragging out the negotiations, but is running out of both cash (government and banks) and time (deadline for negotiating a new MOU, [cough] pardon, "partnership" is June, and Greece continues its unilateral social programs and its
MP's and ministers are openly rejecting compromising, suggesting new elections if Syriza doesn't get it's fantasy deal with Euro). They continue to do lip service, e.g., replacing Varoufakis, repeated lines about
continued privatizations, fulfilling their commitments, etc., etc., but there is no substance. Ultimately, they have only a few choices, e.g., capitulation or referendum/new elections.
Greece is being given a gift by
not being declared in default by ratings agencies if(when?) they miss a payment to the IMF or ECB. But they will still be downgraded, and Greek banks will still see outflows and the ECB will be even less inclined to ease ELA restrictions, and taxpayers will continue to "postpone" payment of taxes and they will circle the drain and, I believe, be forced in to one decision or another by the end of the year, maybe even the summer.
5) Net issuance of Euro debt, after ECB purchases
Zerohedge posted an interesting article (via BNP) about the effect of
net issuance of Euro government debt after QE on rates. That would suggest continued EUR strength for the next few weeks, followed by EUR weakness through the summer and beyond.
Conclusion
If Greece misses payments to private creditors, or the banking system require capital controls, contagion is possible, but likely to be short lived given the options the ECB has said they are willing to use. Buying bonds will push yields down further, sending money looking for higher yields (such as the US) and enabling a large carry trade. If this plays out, I think parity with the US dollar is possible by the end of the year.
But with the continued short-covering, weakness in the US (for now), deflation off the table in Euro, hope still existing for Greece, and net issuance of Euro debt for the next month or so, I think the EUR/USD still has room to move up, maybe, 1.16 - 1.18 by end May/early June. That could change alot, however, depending on this week's US data. I don't have enough conviction to go long EUR/USD because I think it will be a short move, so I will wait for things to play out before deciding if/when to pull the trigger on short EUR/USD in a month or so.
Then again, consensus for NFP is still over 200k, so there still may be opportunity to go long EUR/USD...will watch this week.
