(Bloomberg) — The European economy’s lurch toward recession is making traders ever more convinced the euro will drop below parity with the dollar in the near future.
Shorting the single currency has become one of the most popular trades, while strategists from Nomura International Plc to HSBC Bank Plc have told clients to expect more losses ahead. There’s around a 50% implied probability of the euro hitting parity in the next month, according to a Bloomberg options-pricing model.
With the euro at a 20-year low, investors are grappling with the possibility that Russia may cut off gas supply to Europe and plunge the region into recession. The economic shock would make it harder for the European Central Bank to tighten policy, and likely widen the interest-rate differential with the US. The currency was at $1.0186 Thursday after sliding to $1.0162 on Wednesday.
The euro is a near-impossible trade, especially as the ECB doesn’t appear to have a clear plan on how to address rising inflation and a deflating currency, according to Vasileios Gkionakis, head of European foreign-exchange strategy at Citigroup Inc. in London.
“I’m getting really worried about the recent speeches that have come out the past couple of days that show that there are a lot of concerns and a lot of disagreement” within the ECB governing council, he said on Bloomberg Surveillance on Wednesday. “If the ECB wants to tame inflation and support exchange rates … then it needs to do two things: hike rates and come up with an effective anti-fragmentation mechanism.”
Read more: ECB’s Fragmentation Tool Could Help Ease Collateral Shortage
For Kit Juckes at Societe Generale SA, the euro “remains effectively unbuyable this summer.” The chief global currency strategist said, “Europe’s energy dependency on Russia is falling, but not fast enough to avoid recession if the pipeline is closed. If that happens, EUR/USD will likely lose another 10% or so.”
The ECB will not hike just to strengthen the euro, according Juan Manuel Herrera Betancourt, a foreign-exchange strategist at Scotiabank. The economic shock from an oil cutoff would make it harder to tighten monetary policy and likely widen the interest-rate differential with the US, he said by phone Wednesday. “Where is the floor? It’s hard to say.”
Shorting Euro
Moreover, cutting off Russian supplies may lead to rationing, according to Kaspar Hense, a senior portfolio manager at BlueBay Asset Management in London. If that happens, “we will see a significant recession in Europe. It could be a very long winter,” he said.
BlueBay has been shorting the euro since last month, Hense said. He expects the common currency to slide to 90 US cents if Russia withholds supply, though it’s not their base case.
German officials have been voicing concern that a key pipeline delivering Russia’s natural gas to Europe may not return to full capacity after planned maintenance this month. The International Energy Agency has warned that a complete cutoff in flows “cannot be excluded” given Russia’s “unpredictable behavior.”
Read more: Germany Faces Limited Options If Nord Stream Flows Don’t Return
Tim Brooks, head of FX options trading at market-maker Optiver, is expecting more volatility if the euro breaks through dollar parity. Demand for euro options is coalescing at lower levels from about 0.92 to 1 versus the dollar, he said.
Nomura International Plc strategist Jordan Rochester wrote on Tuesday that he has even more conviction in his call that the euro will slide toward 0.98 by August. ING Groep NV sees a worst case scenario of the euro trading as low as 0.9545 over the next four weeks.
‘Perfect Storm’
There’s also the additional worries about wide Italian bond spreads, said Van Luu, head of currency and fixed income strategy at Russell Investments.
“It’s a perfect storm for the euro at the moment,” said Luu, who holds a small short position. Still, the currency is already at weak levels and there’s a good chance it may strengthen in the next year, he added.
“I wouldn’t rule out parity given the cocktail of factors, but personally I wouldn’t chase this move,” he said. “I wouldn’t add to euro shorts at the moment.”
For months, the euro has been dogged by the view that interest rates in the euro zone will lag aggressive tightening by the Federal Reserve. Traders are also expecting less overall tightening as well because of the region’s feeble economy.
“A lot of capital has flowed into the US, but unless there is something enticing it outwards then the dollar can stay strong,” said Andy Bloomfield, head of macro research at Record Currency Management. “For it to be enticed outwards you need to see a better economic outlook in Europe and other places.”
US stocks suffer sharpest first-half drop in more than 50 years
S&P 500 down 20.6% in 2022 as rising interest rates and growth fears worry investors
The pullback in US stocks has wiped off more than $9tn in the value of the market since the end of 2021
US stocks have recorded their worst first half in more than 50 years after a rout triggered by the Federal Reserve’s attempt to curb persistent inflation and exacerbated by gathering concerns over global growth. The S&P 500 fell 0.9 per cent on Thursday, leaving the blue-chip index down by 20.6 per cent in the first six months of 2022. Wall Street equities have not endured such a punishing start to a year since 1970, when equities sold off in response to a recession that ended what was up to that point the longest period of economic expansion in American history. The pullback in US stocks has eviscerated more than $9tn in market value since the end of 2021, according to Bloomberg data on the S&P 1500 index, a broader gauge which tracks small, mid and large-cap groups. “The market mood is dominated by the possibility of recessions in the US and Europe,” said Bastien Drut, strategist at Paris-based asset manager CPR. “It is very negative,” he added, warning that the days of being able to rely on central banks easing monetary policy to support economic growth were “gone”. The technology-heavy Nasdaq Composite has also tumbled this year, sliding 1.3 per cent on Thursday to take its losses in 2022 to almost 30 per cent. All sectors of the S&P 500 have dropped during the half-year, with the exception of energy stocks, which are 29 per cent higher. Consumer discretionary stocks have fallen the most, registering a 33 per cent decline. Utility stocks, seen as an inflation hedge because of companies’ stronger ability to pass higher costs to consumers, have given up the least, down 2 per cent this year. “Everything has been very inflation-driven,” said Paul Leech, co-head of global equities at Barclays. “It has been the theme of the year and it has just intensified, really.” Across the globe, big stock indices have fallen sharply. Europe’s Stoxx 600 was 1.5 per cent lower on Thursday, leaving it down about 17 per cent this year. MSCI’s index of Asia-Pacific markets has slumped 18 per cent in 2022 in dollar terms. Top policymakers at the European Central Bank’s annual conference on Wednesday warned that the era of low interest rates and moderate inflation had come to an end following the inflation shock caused by Russia’s invasion of Ukraine and the coronavirus pandemic. Fed chair Jay Powell has warned that if the central bank does not raise interest rates high enough to combat inflation quickly, the US could face severe and repeated bouts of price rises that policymakers could struggle to rein in. “The process is highly likely to involve some pain, but the worst pain would be from failing to address this high inflation and allowing it to become persistent,” he added. Markets have been rattled this month by interest rate rises from the Fed and Bank of England, with the former raising the federal funds rate by 0.75 percentage points to a new target range of 1.5 to 1.75 per cent with policymakers signalling another big rate increase next month. The ECB is also planning a quarter-percentage point rise in July for the first time since 2011. “Stubborn inflation readings have precipitated an increasingly hawkish Fed response, tilting the policy focus to fight inflation despite potential economic consequences,” said Scott Chronert, US equity strategist at Citigroup. “Investors are deservedly hesitant to buy ahead of ongoing Fed rate hikes and fear of earnings expectation resets.” Citi also lowered its year-end forecast for the S&P 500 from 4,700 to 4,200 points on Wednesday. While that new target implies a roughly 11 per cent rise from the benchmark’s current level, economists at the bank also placed the odds of a global recession at 50 per cent.
Biggest Forex Rout Since ‘97 Puts Asia Central Banks in Bind
(Bloomberg) — The surge in the dollar has set Asian currencies on course for their worst quarter since the 1997 financial crisis and created a dilemma for central bankers.
Policy makers already grappling with the fastest inflation in decades now face stark choices: forcefully raise borrowing costs to defend currencies and risk hurting growth, spend reserves that took years to build to intervene in foreign exchange markets, or simply step away and let the market run its course.
Read more: Studying 25 Years of Crises Shows Asia Coping Surprisingly Well
The Bloomberg JPMorgan Asia Dollar Index is poised for a 4.5% drop this quarter, the steepest since the crisis pummeled currencies almost 25 years ago. Central banks in the region have lagged emerging-market peers in raising rates as they seek to boost the recovery from the pandemic, and that more patient policy stance is weighing on their currencies as the Federal Reserve pushes ahead with big hikes.
“Central banks are thrust into a difficult position to tighten, even as the recovery from the pandemic is not yet complete and with the specter of a US recession ahead,” said Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore. “Complicating the picture is the strong greenback, which adds to the pressure to tighten as weak currencies exacerbate imported inflation.”
South Korea’s won is set for its largest monthly decline in 11 years, while the Philippine peso is headed for its worst quarter in 14 years. In India, the central bank is fighting on several fronts to slow the rupee’s decline to fresh records.
Meanwhile, the yen, which is not part of the index, has lost 11% of its value against the dollar since the end of March amid a growing yield differential with the US as the Bank of Japan sticks to its ultra-easy monetary policy.
Change Tack
But Asia’s central banks may have to change tack as consumer prices steadily move up and weaker currencies add to concerns about imported inflation. Bangko Sentral ng Pilipinas has said it will consider larger rate increases after two quarter-point moves, while Bank of Korea has kept the door open for a larger-than-usual hike in July.
“Inflation is proving to be persistent and central banks may have to move ahead of schedule and be even more aggressive than expected,” said Eddie Cheung, senior emerging-markets strategist at Credit Agricole CIB in Hong Kong. “Growth is still holding up for the time being and that gives them leeway to focus on fighting inflation.”
Currency depreciation could cause regional central banks to tighten “if it adds to import-led inflation on top of the supply-side inflation already seen,” Morgan Stanley economists led by Deyi Tan wrote in a report published Sunday. The analysts expect rate hikes to continue on surging inflation expectations.
Central banks have already drawn billions of dollars from their foreign-exchange reserves to slow the declines in their currencies. Stockpiles in Thailand and Indonesia have fallen to their lowest since 2020, as officials pledge to curb volatility in their currencies, while thus far holding off on raising rates.
The region is in a much stronger position than in 1997, and in 2013 during the Taper Tantrum, after accumulating trillions of reserves. India’s authorities have built up a stockpile of almost $600 billion, while South Korea’s stash exceeds $400 billion.
But the worst may be yet to come for Asian currencies as the Fed has signaled another big increase in July, with traders pricing a 75 basis-point hike. Goldman Sachs Group Inc. has warned high-yielding currencies such as the Indian rupee and Indonesian rupiah may reel amid deteriorating external finances and as the Fed tightening spurs risk-off sentiment.
To be sure, even with currencies tanking, “central banks across the region are unlikely to go anywhere near matching the Fed’s rate hikes like-for-like,” Miguel Chanco, chief emerging Asia economist at Pantheon Macroeconomics Ltd., wrote in a report Monday. “Reserves remain ample, and are likely to continue to be used to lean against excessive currency volatility.”
