Market's Bullishness On Euro Against Dollar Looks Misplaced

Authored by Simon White, Bloomberg macro strategist,

Speculators long the euro versus the dollar look out of step with real-rate differentials. However, the short positioning in the euro versus sterling looks more in tune with the interest rate outlook.

Overall, speculators are flat the dollar, based on the Commitment of Traders report. But this masks a long in EM FX versus the dollar, and a short in DM FX. That’s pretty much been the theme for the last year, although the conviction on the DM short has been much more hesitant, with the net dollar long versus DM currencies more muted than the short dollar versus EM FX.

Most of this makes sense through the prism of real-rate differentials. All of the major countries with higher vol-adjusted real rate differentials than the US are EM, such as Mexico, Brazil and India. All DM FX have lower real-rate differentials; the only major EM currencies also with lower differentials than the US are the Taiwanese and Singapore dollars, the Korean won and, unsurprisingly given the country’s stratospheric inflation rate, the Turkish lira.

So far so good – positioning is largely aligned with real-rate differentials. But within the aggregate positions there are a couple of anomalies. Most notable is the euro. The overall net short in DM currencies masks the long positioning in sterling and the euro.

Both the UK and Europe have lower real-rate differentials than the US, but the expected rate path for the Fed sees fewer cuts than at the BOE in 2024. Europe’s real policy rate, however is expected to be lower than the US’s at the end of this year. Thus the long positioning in the euro looks more out of step with real-rate differentials.

This is also inconsistent with positioning in EURGBP, which does look in line with differentials. As the chart above shows, speculators are quite short the euro against sterling, relative to the last two years. Real rates are lower in Europe compared to the UK, and if we use CPI fixing swaps, the real rate in Europe is expected to fall ~65 bps in 2024, versus rising ~25 bps in the UK.

Shorts in the euro versus the pound look to be reflecting the rate trajectory, while longs in the euro versus the dollar may find the wind against them this year.