How would EUR react to an improvement in risk sentiment? Here is an answer from Morgan Stanley Global FX Strategy Team.
"This is complicated, as EUR’s relationship with risk continues to evolve. Earlier this year EUR developed a strong negative relationship with global risk appetite, as the ‘ECB QE’ trade gained traction. Foreign investors bought European equities on an FX-hedged basis, and negative European rates encouraged funding in EUR. But a correction higher in European bond yields in the spring and Greek political concerns in summer unwound this trade. Falling European equity valuations forced automatic hedge adjustments and thus EUR buying.
In this way EUR has exhibited behavior typical of JPY – falling on good news and rising on bad. As additional global concerns have captured market attention, EUR’s inverse relationship with global sentiment has risen.
To measure this, we revert to our drivers model, which tracks betas of currencies to particular high-frequency drivers. EUR/USD used to have a positive beta to S&P 500 (green line), but this has moved sharply into negative territory. Just as EUR’s negative relationship to a global risk benchmark (SPX) has grown, its sensitivity to local risk (Eurostoxx out/underperformance) has declined. Some possible explanations include less automatic hedging behavior due to reduced foreign investor positioning in European equities or European concerns no longer driving global risk sentiment. We will need to continue to monitor this relationship, along with European flow data, to gauge the Eurostoxx-EUR relationship.
But as of now there is little sign that EUR’s inverse correlation to global risk is in decline. An easing of global market volatility would allow for EUR weakness," MS clarifies.
MS targets EUR/USD at 1.13 by the end of the year.
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"This is complicated, as EUR’s relationship with risk continues to evolve. Earlier this year EUR developed a strong negative relationship with global risk appetite, as the ‘ECB QE’ trade gained traction. Foreign investors bought European equities on an FX-hedged basis, and negative European rates encouraged funding in EUR. But a correction higher in European bond yields in the spring and Greek political concerns in summer unwound this trade. Falling European equity valuations forced automatic hedge adjustments and thus EUR buying.
In this way EUR has exhibited behavior typical of JPY – falling on good news and rising on bad. As additional global concerns have captured market attention, EUR’s inverse relationship with global sentiment has risen.
To measure this, we revert to our drivers model, which tracks betas of currencies to particular high-frequency drivers. EUR/USD used to have a positive beta to S&P 500 (green line), but this has moved sharply into negative territory. Just as EUR’s negative relationship to a global risk benchmark (SPX) has grown, its sensitivity to local risk (Eurostoxx out/underperformance) has declined. Some possible explanations include less automatic hedging behavior due to reduced foreign investor positioning in European equities or European concerns no longer driving global risk sentiment. We will need to continue to monitor this relationship, along with European flow data, to gauge the Eurostoxx-EUR relationship.
But as of now there is little sign that EUR’s inverse correlation to global risk is in decline. An easing of global market volatility would allow for EUR weakness," MS clarifies.
MS targets EUR/USD at 1.13 by the end of the year.
This content has been provided under specific arrangement with eFXnews.
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