According to George Saravelos, Strategist at Deutsche Bank, something strange has happened to the euro in recent months as almost all traditional drivers that usually “explain” the price action have broken down.
“One way to show this is to look at rolling 3m correlations between EUR/USD and other variables, and plotting the highest prevailing correlation over time. Among a list of thirty variables including rate diﬀerentials, relative equity performance and peripheral spreads the last time correlations were so low was in 2007 and early 2014, both years of exceptionally low volatility.”
“What conclusions can we draw from this? Near-term, it suggests that there may be an underlying ﬂow story that is impervious to other market drivers and is supportive of the euro. We have previously identiﬁed unhedged equity inﬂows as the most likely candidate. These are approaching previous peaks and have typically lagged relative EU-US equity market performance which is why the correlation between equities and the euro is not high. Medium-term, the current “decorrelation” is usually associated with periods of very low volatility and would suggest caution in extrapolating recent euro strength. Traditional drivers tend to re-assert their inﬂuence over time and as we argued in the FX Blueprint these mostly show EUR/USD as too expensive. Our view is that EUR/USD will not break out of the top end of its 1.05-1.15 range and if Draghi tomorrow signals ECB discomfort with further appreciation it would make the hurdle for further strength even greater.”
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