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(Bloomberg) — The euro, which hit a nearly two-year low last month as war in Ukraine raged, may have bottomed out as the market braces for the European Central Bank end an era of negative policy rates.
Money markets are betting the ECB could raise its deposit rate to zero by December for the first time since 2014, and suggest strategies based on shorting the currency to fund higher-yielding positions could hit at their end. The common currency has already staged a mini-rally, surging more than 2% against the dollar as talks between Russia and Ukraine helped boost sentiment further.
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Just last month, analysts were speculating that the euro would fall to parity with the dollar given Europe’s geographic proximity to the war and its dependence on Russian energy. Now, spurred on by policymakers who have reiterated that a rate hike is possible this year to rein in record inflation, some traders are bracing for further gains.
“Russia-Ukraine talks have allowed FX markets to focus on other more positive drivers for the EUR, such as the increasingly hawkish ECB,” wrote Credit Agricole strategists, including Valentin Marinov, in a note to clients.
This marks a change for the central bank, which has been seen as staunchly dovish unlike the Federal Reserve and the Bank of England. The change in tone pushed yields higher, helping to erode the region’s stock of negative-yielding debt to less than $1 trillion for the first time since 2014.
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Deutsche Bank AG said the market still undervalues the positive effect of this “regime shift” for the euro. Santander sees a bottom at $1.10 as the currency is supported by more stable risk appetite and the fact that the greenback’s further strength appears to be capped now that markets have priced in Federal Reserve policy.
New collection?
While the Euro has remained in a downtrend channel since late May, it has been trading on a more bullish tone for the past three weeks. Momentum indicators such as Fear-Greed and Moving Average Convergence-Divergence gauges argue for a settlement of the currency within a range capped at $1.09 – $1.10 at the lower end .
That said, RBC currency strategist Adam Cole expects the euro to “downtrend” over the course of the year as bets on ECB rate hikes could be overdone relative to the fed. Bank of America strategists, including Michalis Rousakis, see the euro-dollar pair falling further to $1.05 by the end of 2022 due to policy divergence and growth prospects that have been “significantly downgraded” in the past. middle of the war in Ukraine.
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bear retreat
Options bets, meanwhile, paint a less bearish outlook for the common currency. Risk reversals, a barometer of market positioning and sentiment, have negated the war-induced move in Ukraine and are trading at levels seen earlier this year.
Should the common currency manage to stay within the higher highs and lows in place since early March, risk reversals could extend its move towards parity, representing more balanced options exposure for investors.
To liberate oneself
The decomposition of the correlation between the spot market and the interest rate differentials is also useful. The common currency rose even as the spread between US two-year yields and the equivalent German bills widened. The pricing also supports the view that the pricing of the Fed’s price hike cycle may have peaked.
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Hot inflation
Some Euro bulls may also expect the ECB to raise rates faster than currently expected. Medium-term inflation expectations continue to rise and argue for a rally in the Euro, especially after higher than expected inflation prints. of the region’s largest economies last week.
This week
Debt sales from Germany, France, Spain and Austria are expected to total nearly 20 billion euros ($22 billion), according to Citigroup Inc Danske Bank A/S expects for the European Union to sell a 20- or 25-year NGEU green bond via banks for up to €7 billion last month’s policy meeting, while the pace of scheduled speeches is expected to slow, with chief economist Philip Lane speaking on Wednesday ahead of a self-imposed start to a quiet period ahead of the April 14 monetary policy decisionGovernor Andrew Bailey is among the Bank of England’s scheduled speakers
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