Dollar Seen Casting Off Euro Shackles as Fed Tapers: Currencies

By Joseph Ciolli - Aug 29, 2013 12:53 AM PT

The euro, more than any other currency, is responsible for the drop in the U.S. Dollar Index (BEUR) since March. Derivatives traders are betting that’s about to end as the Federal Reservereduces stimulus as soon as next month.

Traders are paying the biggest premium since September for options giving the right to buy the dollar versus the euro over those allowing for sales. The Dollar Index, which is 58 percent weighted toward the shared currency, will climb almost 5 percent to 85.8 by Dec. 31, from 81.806 today, according to the median forecast of 12 analysts in a Bloomberg survey.

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The dollar is already the second best-performer this year of major currencies tracked by Bloomberg Correlation-Weighted Indexes, rising 5.4 percent compared with the euro’s 6.1 percent advance. Photographer: Andrew Harrer/Bloomberg

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The dollar is already the second best-performer this year of major currencies tracked by Bloomberg Correlation-Weighted Indexes, rising 5.4 percent compared with the euro’s 6.1 percent advance. Further gains may be in store if the Fed reduces its $85 billion of monthly bond purchases, stemming the flow of cash to the 17-nation region.

“Tapering will eventually support the dollar against the euro,”Robert Lynch, a currency strategist at HSBC Holdings Plc inNew York, said in an Aug. 26 phone interview. “It will put some downward pressure on currencies that have been otherwise supported by the liquidity the Fed has been pumping into the economy.”

Risk Reversals

Futures traders are betting that the dollar will keep gaining versus major peers including the British pound, Japanese yen and the Canadian and Australian dollars, CFTC data show.

The premium on one-year options granting the right to buy the dollar against the euro, compared with those allowing for sales, increased to 2.1 percentage points yesterday, according to so-called 25-delta risk reversal rates. That’s the most since Sept. 11 and up from a premium of 0.98 percentage point on Feb. 1, data compiled by Bloomberg show.

“From the U.S. side of the story, in terms of the prospects of new positions, the risk-reward doesn’t favor a higher euro,” Paresh Upadhyaya, the Boston-based director of currency strategy at Pioneer Investment Management, which oversees $210 billion, said in an Aug. 27 phone interview. “But we still need the U.S. economy to surprise to the upside.”

The Dollar Index, which IntercontinentalExchange Inc. uses to monitor the greenback against the euro, yen, pound and the currencies of three other major U.S. trading partners, has fallen 1.1 percent since the end of the first quarter.

Euro Strength

In the same period, the dollar climbed versus 11 of its 16 most-traded peers tracked by Bloomberg, while weakening 3.4 percent against the euro. Europe’s common currency touched $1.3452 on Aug. 20, the highest level since Feb. 14, before trading at $1.3265 as of 8:44 a.m. in London

Global monetary easing has boosted European assets as the economy improves and investors speculate that the chance of a euro-region breakup has receded.

The Bloomberg Eurozone Sovereign Bond Index (BGSV) has rallied 19 percent from a low in November 2011, while the Bloomberg Global Developed Sovereign Bond Index has fallen 1.8 percent.

Futures traders increased bets that the dollar will weaken against the euro in the week ending Aug. 20, figures from the Washington-based Commodity Futures Trading Commission show.

The difference in the number of wagers on a decline in the greenback versus those on a gain -- or net shorts -- rose to 36,746, the most since Feb. 8 and up from 16,057 the prior week.

Dollar ‘Upside’

“Now that speculators are a bit long the euro, it creates a short-term opportunity for a squeeze that would work in the dollar’s favor,” HSBC’s Lynch said. “If economic conditions were to warrant it, this suggests upside for the dollar.”

The euro-area economy emerged from a record six quarters of recession in the April to June period, with gross domestic product growing 0.3 percent.

Citigroup’s Economic Surprise Index for the euro region has exceeded an equivalent measurefor the U.S. since June 26, with the difference reaching a peak at the end of last month.

The European gauge rose to 50.2 on Aug. 27, the highest level since March and up from minus 81.6 on April 29. Positive readings suggest economic releases have been generally better than analysts’ forecasts in Bloomberg surveys.

“This data is a big part of why the euro is doing well against the dollar,” Dan Dorrow, the head of research at Faros Trading LLC in Stamford, Connecticut, said in an Aug. 27 phone interview. “The market has already priced in tapering in September. I just can’t see the Fed surprising the markets on the hawkish side.”

Policy Split

Fed Chairman Ben S. Bernanke told Congress on May 22 that the central bank could dial back the money printing it has used to boost growth should the economy improve.

Minutes of the Federal Open Market Committee meeting published Aug. 21 show that most members were “broadly comfortable” with a plan to trim stimulus in 2013, while 65 percent of economists surveyed by Bloomberg Aug. 9-13 anticipated tapering in September.

European Central Bank President Mario Draghi said in July that he won’t raise the region’s benchmark interest rate from a record-low 0.5 percent for an extended period, and reiterated the statement this month.

“The ECB is still biased, in contrast to the Fed, to providing a bit more stimulus or remaining in the camp of saying rates will be low for longer,” David Tulk, the chief macro strategist at Toronto-Dominion Bank’s TD Securities unit, said in an Aug. 26 phone interview. “That relative divergence in policy will play a role in dollar strength.”

To contact the reporter on this story: Joseph Ciolli in New York at jciolli@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net