Why would you sell the euro at 1.12 for a 1.04 target?

ECB chief Mario Draghi has publicly stated that the ECB Governing Council would ‘reconsider’ monetary policy at its March conclave.
ECB chief Mario Draghi has publicly stated that the ECB Governing Council would 'reconsider' monetary policy at its March conclave.

I believe the fall in the US dollar in the past week and the oil short covering rally will not last. This is a classic opportunity to short the euro at 1.12 and the Canadian dollar at 1.3680. Despite the mediocre 0.7 per cent rise in fourth-quarter GDP, US growth prospects trump (no pun intended after Iowa!) the growth prospects of either Canada or the EU.



By Matein Khalid

Published: Sun 7 Feb 2016, 11:00 PM

Last updated: Mon 8 Feb 2016, 8:00 AM

Yes, last week was the time to finally buy sterling as cable rose from 1.42 to 1.46. Brent crude prices surged eight per cent to $35 on Wednesday as rumours about a Saudi-Russian output deal circulated in the world oil market. This oil rally, in turn, led to a rise in the Canadian dollar to 1.3680 and the euro to 1.12 as Planet Forex scrambled to sell US dollars. Yet I doubt if the Brent rally will last since Iran is determined to increase its post-sanctions oil exports to at least one MBD and Saudi Arabia is not willing to concede its China market share to Iran or Iraq. US crude oil inventories, 350 million barrels in early 2015, have risen to 500 million barrels now, the highest February level in the history of the post-war energy market.
I believe the fall in the US dollar in the past week and the oil short covering rally will not last. This is a classic opportunity to short the euro at 1.12 and the Canadian dollar at 1.3680. Despite the mediocre 0.7 per cent rise in fourth-quarter GDP, US growth prospects trump (no pun intended after Iowa!) the growth prospects of either Canada or the EU. While I doubt if the Federal Reserve will raise the Fed Funds rates in the March FOMC after the Bank of Japan shock easing, a June rate hike is still possible. I cannot own euros at a time when Dr Draghi has publicly stated that the ECB Governing Council would review and "reconsider" monetary policy at its March conclave.
This means the ECB's negative-0.3 per cent deposit rate will fall to negative-0.4 per cent, as the plunge in two-year German Bund yields suggest. The message from the ECB at a time of deflation risk, a growth slump and political risk (migrants, terrorism, Spain, Greece, Brexit, Merkel) is crystal clear. Short the euro at 1.12 for a 1.06 target. The Chicago futures markets is still short euro ($17.3 billion net short, CFTC data). The recent bid in the euro was only because January's selling waves in the global equity and speculative credit markets was financed by short Euro positions. As leveraged hedged funds slashed market exposure and leveraged positions, they squared euro shorts that triggered a short covering euro bid in the market.
Yet ECB policy, inflation data, relative growth, interest rate spreads and politics still convince me that the euro is a short at 1.12. Europe is China's largest trading partner and the big chill from the Middle Kingdom as history's biggest credit bubble explodes will not compensate for $30 Brent or an ultra-dovish ECB. The EU's growth prospects are fragile, held back by rigid labour/pensions markets, unviable welfare states, near bankrupt banking systems, the refugee crisis, xenophobia (and anti-euro) right wing parties, a secular slump in exports to China/emerging markets all heighten deflation risk at a time when Dr Draghi does not remotely meet the ECB's inflation mandate.
Even the hard money zealots of the Bundesbank have succumbed to Dr Draghi's "whatever it takes" monetary mantra. So the game's afoot and the die is cast. Let me not lose another opportunity to expose myself to public ridicule if I am wrong (though adoring e-mails and offers of dinner at Zuma if I am right!). I believe the ECB will cut its deposit rate to minus-0.4 per cent and increase its monthly bond purchase, a de facto "shock and awe" monetary ease, at its March policy meeting. So I take advantage of the current euro strength to short the single currency at 1.12 for a 1.04 strategic target sometime this summer.
I had recommended a long Canadian dollar trade at 1.46 for a 1.38 target since I thought the loonie had overshot even its mediocre fundamentals in January. The oil price rise was only the icing on the cake for the macro loonie idea. Yet fiscal stimulus form Ottowa rules out another Poloz rate cut. Though oil/mining capex will devastate Alberta and the Prairie states, services, construction and consumer credit in Ontario, Quebec and the Atlantic provinces enable Canada to deliver one per cent GDP growth. Hopefully, the loonie J-curve will boost auto component/manufacturing exports to Gringolandia south of the border.
In retrospect, the 13 per cent plunge in the loonie against the US dollar since October alone was a license to print money. At 1.47, the loonie was grossly oversold relative to its valuation metrics. Trend is only your friend until it comes to an end. The risk reward calculus suggests long Canada against the Japanese yen at 85 for a mid-summer 93 target.
Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at: matein@emirates.net.ae


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