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Summary
- EUR/USD has bounced about 2% since bottoming out on a 1.03 handle (intra-day) last week.
- This has coincided with a decline in US yields across the curve.
- Crowded short positioning, plus oversold technicals that are starting to unwind, have also contributed to the rise in EUR/USD.
Market Implications
- We still think EUR/USD can rally into year-end.
EUR/USD Has Bounced from Last Week’s Two-Year Low
Until this week, Q4 had been a torrid quarter for EUR/USD. The pair closed on 30 September at 1.1135, at the time up about 1% year-to-date. But it then slid to its lowest level since late 2022, hitting 1.0335 on an intraday basis on 22 November.
Since the close of business on Friday, however, EUR/USD has bounced ~1.3%, and it is up about 2% from the intraday low (Chart 1).
Drop in US Yields Has Been a Key Driver of the Bounce
The Q4 price action in EUR/USD has been driven largely by the gyrations in US yields.
Last week, we argued the most notable driver of USD strength in recent months has been the sharp rise in US yields.
This dynamic shifted this week, with those US yields tumbling across the curve. Since the close of business last week, the 2-year US Treasury yield has fallen ~15bps, unwinding a decent chunk of the preceding ~65bp up move in Q4 (Chart 2).
There has been a similar dynamic in the US 10-year yield (Chart 3).
Crowded EUR/USD Short Positioning Is at a Multi-Year Extreme
Recent CFTC FX data revealed that leveraged funds (LF) EUR shorts are at a multi-year extreme. In Chart 4 below, the zero line represents neutral positioning. Anything above the zero line represents net long exposures, while anything below represents net short exposures.
These net shorts have become more extreme in the period preceding, during, and after the US election, when Trump trades increasingly became de rigeur.
High on the list of favoured Trump trades is short EUR/USD, and this positioning data shows that LF have piled in to the trade.
In addition to this stretched short positioning from LF, we are also seeing a strong short bias from momentum players.
Over a similar timeframe to the CFTC shorts building up, the period straddling the election has seen momentum models also ramp up long USD positioning, including against the EUR (Chart 5).
This combination of CFTC shorts and bullish USD biases from momentum players leads us to conclude that short EUR/USD is stretched.
Oversold Technicals Have Started to Unwind
From a technical perspective, there are also signs that EUR/USD downside impetus has run out of steam.
Last week, the EUR/USD RSI moved below 30.
Regular readers will know that the RSI is an important tool used by technical analysts, and that the ‘30/70 rule’ is an effective (and widely used) guide for determining whether a security is overbought or oversold.
With last week’s move below 30, the EUR/USD RSI flagged the currency pair as oversold. And in what has so far been a textbook move, EUR/USD bounced and the RSI has moved back above 30 (Chart 6).
In Sum: Room to Run
As a result of all the above, we think the EUR/USD bounce still has room to run.
US yields are showing signs of having topped out (for the near-term, at least).
Short EUR/USD positioning, as evidenced from CFTC data and momentum models’ biases, looks to have become crowded, and is beginning to unwind.
And, looking at technicals, EUR/USD has begun unwinding its oversold RSI, a dynamic which can extend.
The next few days, with the US Thanksgiving holiday having begun, will be relatively quiet. The next big event risk will be US jobs data next Friday.
As we approach that key release, EUR/USD has started a run higher that we think can continue into year-end.
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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)