Euro to dollar sellers should book profits on risk versus reward considerations

“I wouldn’t be short of Euros by September 8. The risk/reward balance looks poor to me,” said Brent Donnelly, Spectra Markets.

Image © European Central Bank

The euro to dollar exchange rate has rallied back above the parity milestone and it is possible that some of this price action reflects concerns from speculative sellers that the risk of betting against the single currency can no longer be justified by the potential benefits of doing so.

The European single currency entered the week below the one-to-one level, but hit 1.0078 on Wednesday and was still above parity on Thursday after favorable developments in gas and electricity prices as well as hawkish comments from the European Central Bank (ECB) rate setters.

It’s unclear which was the biggest driver of the euro-dollar rally, but Europe’s single currency remained the best performer among G10 currencies for the week on Thursday and was the second-best performer among the G20 currencies, behind the Polish zloty.

“There is a bit of a change in sentiment here in EURUSD. Several people who I would consider ahead of the curve will be covering EURUSD shorts or discussing long EUR crosses over the week or next two,” said Brent Donnelly, president of Spectra Markets and a veteran forex trader.

“The huge gamma pocket in the 0.9900/1.0000 area served as a giant baseball glove to catch EURUSD’s fall and now the stage is set for a slight rally. And EURCHF was the canary because it bottomed first and it is the most crowded EUR short ever,” Donnelly wrote to subscribers to the daily market newsletter. AMFX this week.

Above: Euro to dollar exchange rate displayed at hourly intervals alongside S&P 500 stock index futures.

The euro first tested the parity level against the dollar in the first weeks of July and was quoted as low as 0.9903 in the six weeks that followed, but only after a loss of significant momentum for a downtrend in place since January 2021.

Donnelly and others have attributed this loss of downward momentum to institutions that buy the euro to hedge or protect against the risks associated with currency option transactions between them and their clients, although some have also signaled further reasons for a more cautious approach to EUR/USD in the days ahead.

“I have no idea what form intervention in the EU electricity market might take, but when policy makers tell you they are about to change the rules, it is worth it. to consider that the rules might be about to change,” Donnelly said.

European Commission President Ursula von der Leyen told a summit in Slovenia this week that electricity costs were unnecessarily inflated by the price of natural gas and announced that Brussels will seek to reform the electricity market in the first months of next year.

Wholesale gas and electricity prices fell throughout the week, but the euro’s rally was also accompanied by “suggestions from ECB policymakers that they might debate following in the footsteps of the Federal Reserve next week with a 0.75% increase in interest rates in September.

Above: The Euro/Dollar exchange rate is shown at daily intervals along with the Dutch wholesale gas futures price and the spread or spread between German government bond yields and American at 02 years old. Click on the image for a closer inspection.

“A recovery in the euro will likely be helped by early buying (new longs and hedging shorts) at the ECB meeting, as they suddenly got some religion on inflation for some reason,” Donnelly said. .

“While the payroll and the end of the month are event risks by then, I would not be short of euros by September 8. The risk/reward ratio seems poor to me,” he said. he adds.

The ECB cut its previously negative deposit rate to zero in July and warned that further increases would be needed due to the continued sharp rise in inflation rates in Europe.

Eurostat revealed on Thursday that inflation hit a new all-time high last month and higher than economists expected, leading many to raise the ECB’s interest rate forecast for September and beyond. of the.

But while economists have become more hawkish, and some policymakers may be leaning more in that direction, European Central Bank chief economist Philip Lane has been less convinced of the possible merits of a hike. higher in interest rates in September.

“A steady pace (that is neither too slow nor too fast) to close the gap with the terminal rate is important for several reasons,” he said at one point in an address at the 2022 annual meeting of the Central Bank Research Association (CEBRA) in Barcelona on Monday.

Above: exchange rate between the euro and the dollar displayed at weekly intervals. Click on the image for a closer inspection.