EUR/USD defies gravity on relentless unwind of the carry trade

 EUR/USD has extended its upside to a high of 1.1165 as the carry trade continues to unwind despite a bid in risk appetite elsewhere. At the time of writing, EUR/USD is trading at 1.1172 having climbed from a low of 1.1036.

Markets out of synch

Looking across the board, the MSCI index is breaking fresh lows, equities are firmer, the US dollar weaker, the commodity indexes are perking up and US yields are printing fresh record lows – that's quite a soup of out of synch market dynamics owing to the risks surrounding the coronavirus and a subsequent shift of portfolio positions for which is supporting the euro. 

Markets are dumbstruck as the virus surpasses 3000 deaths and global cases approach the psychological 100,000 mark. In recent news, some solace can be found in the International Monetary Fund and World Bank who have issued a joint statement on the coronavirus, saying they are prepared to provide financial and technical help to their member countries. 

However,  the USD has dropped in the spot market on talks of the Federal Reserve easing as soon as this month and owing to the unwind of carry trades, coupled with record lows in the US Treasury yields, the euro is firmly on the bid. Net positioning on the euro was at a nine-month low (-18% of open interest) ahead of the squeeze which also helps to explain the rally, not to mention the fuel in the buy stop liquidity in counter positions from 1.1080/20.'

"The level of realized volatility matters for the euro," Hanswolf Hohn at Deutsche Bank argues. "Recent depressed levels of vol have sucked investors into euro funding as carry to vol ratios havestayed very elevated. EUR/USD carry to vol ratios have already collapsed in recent days and will likely continue to move lower. The danger is we enter a self-fulfilling unwind of euro funding."

EUR/USD levels

Looking to the carry positioning since the sell-off in EUR/USD in Jan 2018, the volume profile has a volume point of control (VPOC) located at 1.1335. At this juncture, the pair is testing the 2019 winter highs and resistance and trendline from the Sep 2018 highs. A pullback to the 3rd Feb highs would marry with the 2020 VPOC at 1.1091 and a 23.6% Fibo retracement of the recent rally.