- The euro has rightfully strengthened in 2017, with the tailwinds of politics and growth
- Today, long euros is the global consensus trade based on expectations of imminent tapering
- Politics and monetary policy going forward both look shaky, and remaining a bull will take courage
For a currency that faced chatter of its ultimate demise only a few months ago, the euro had staged an incredible comeback following Macron’s victory in the French presidential elections. In recent months, the currency has continued to strengthen thanks to rising expectations that the ECB is set to normalize its monetary policies. The Bank continues to operate a substantial quantitative easing program, which the market expects will be tapered shortly. In addition to monetary policy, Macron and Juncker have sought to keep political momentum alive, by advocating the idea of moving towards a federal republic model (similar to the United States of America). All in all, the euro has had no shortage of reasons to strengthen since last April.
Is the ‘United States of Europe’ really in the cards?
Two weeks ago, European Commission Juncker delivered a triumphant speech and called for the union to further integrate. In particular, he called for the harmonization of many government functions such as unified tax rates, a common military and intelligence unit as well as a single President that would “reflect the true nature of…a Union of States and a Union of citizens.” Macron’s vision for the EU followed similar themes, as he called for “a real budget at the heart of Europe” with a finance ministry and a permanent monetary fund.
Following the outcome of the recent German elections, Macron’s vision for a more unified EU capable of fending off nationalist threats seems less likely. Merkel’s CDU/CSU needs 355 seats in order to form a government, and the most likely coalition will involve the Greens and the Free Democrats (FDP). The outcome of the German elections are shown below.
A unified Europe without a unified Germany?
The FDP has already responded to Macron’s speech, making it clear that “there will be no Eurozone budget” given the party’s “red lines”. The Macron/Juncker vision of a more political union also has many detractors in Eastern Europe. The next expected Czech Prime Minister, Andrej Babis, commented that Macron “should really concentrate on France”. With Germany set to look inwards and skepticism toward further centralization, the US of Europe is looking less and less likely.
Monetary policy: “recalibration” vs. “exit”
Looking at the ECB, recent indications for future monetary policy have been fairly reluctant. As we wrote in our morning note on the euro, the ECB's chief economist Praet yesterday stated that the Bank will seek to "recalibrate" existing policies as opposed to discussing an "exit". Earlier in 2015, Draghi stated that lowering bond purchases was closer to a recalibration, while an exit implied an eventual end to quantitative easing.
Speculators have been betting on the ECB’s ‘inevitable’ capitulation for several months now, given the widely held belief that the ECB is running out of bonds to buy. This has resulted in large speculator positions in euro futures, looking at data from the CFTC.
We have consistently warned that speculator optimism towards the euro has been excessive in the last few weeks. Beyond large positions in the futures market, the ECB has substantial room to modify the parameters of its quantitative easing program (for example: by expanding the number of securities available for purchase), giving it substantial room to disappoint euro longs. The ECB's ultimate exit from quantitative easing is thus far from 'inevitable' today. Coupled with the euro moving into deeply overbought territory when looking at technical indicators, the currency is highly susceptible to a pullback. Today, it takes guts to remain a euro bull.