News of heightened sanctions on Russia is likely to weigh on the EUR for three reasons, argues Morgan Stanley.
First, following a string of negative economic data surprises, Europe can ill-afford retaliatory trade measures from Russia, a key export destination.
Second, increased geopolitical risk (and perhaps direct supply restrictions) may well increase natural gas and oil prices, placing an effective tax on European consumers.
Finally, US restrictions on USD funding of certain Russian institutions will further raise the costs of funding in USD. To the extent that this leads to a transition of funding from USD into EUR, there will be marginal EUR weakness.
Moreover, MS notes that yield differentials are now at their lowest levels since 2007, suggesting that EUR is becoming increasingly vulnerable, while short positioning is also still relatively light, suggesting that there is scope for further downside.
Technically, MS thinks that a sustained break below 1.3500 would open the way for a decline towards 1.3295 initially, ahead of our medium-term target at 1.3100.
In line with this view, MS maintains a short EUR/USD position as a short-term trade recommendation from 1.3600, with a revised stop at cost, and a target at 1.31. MS holds a similar position in its medium-term portfolio from around the same entry (1.3620), with also a revised stop at cost and a target at 1.31.
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