(Bloomberg) — The euro’s August gains have been relentless, taking it to a one year high against the dollar on Wednesday, but a cautious tone from Federal Reserve Chair Jerome Powell on Friday could turn that momentum around.
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There’s about $2.29 trillion of turnover each day in the euro-dollar currency pair — around a third of all foreign-exchange volume globally. Because it’s so easy for sellers to find buyers, and vice versa, it has long been the easiest way for market participants to take a bearish punt on the US economy.
Every day for the past two weeks, money-managers betting the Fed is on the cusp of an interest-rate cutting cycle have snapped up the euro, according to Bank of New York Mellon. As the world’s biggest custodian bank, it has a bird’s-eye view of more than $45 trillion of assets.
Robo-traders are also in on the action. Managers deploying computer algorithms to chase the latest market trends have dumped between $70 billion and $80 billion so far this month. According to UBS AG, the euro has been one of the main beneficiaries.
That’s all fueled the euro’s 3% rally since the start of the month to as much as $1.1143 on Wednesday, its strongest since last July. It got an added boost after revised US jobs data bolstered bets for Fed rate cuts.
But as the world’s central bankers convene on Jackson Hole, and with European growth still lackluster, many fear the euro’s fortunes are about to turn.
All it would take is for Powell or his lieutenants push back against the scope of cuts implied by the market, strategists say. That would suggest US rates will stay higher relative to those in Europe, where reductions have already begun, burnishing the dollar’s appeal.
The euro is “the main beneficiary of the ongoing pullback in US rate expectations and the improvement in risk appetite,” said Geoff Yu, senior strategist at Bank of New York Mellon. “It’s not an outright euro-positive story, the current macro picture for Europe remains very weak.”
The single currency’s gains may have more to do with its superior liquidity than any fundamental change in the outlook for the region’s economy.
Europe’s Growth Woes
“It can be a smooth and easy way of expressing one’s view against the dollar,” said Stephen Jen, chief executive officer at Eurizon SLJ Capital. “This is more a dollar weakness story than a strong euro one, because euro fundamentals haven’t changed much.”
Signs of economic trouble have mounted across the eurozone and confidence in its largest member — Germany — has tumbled. Growth risks have reinforced the case for policy easing to resume when the European Central Bank meets next month, according to governing council member Olli Rehn.
For now, aggressive US easing bets have masked that economic weakness for the euro.
Aspect Capital Ltd’s quantitative models have flipped from short to long the euro over the last six weeks, with opportunity for the currency to rise against the pound, franc and Norwegian krone. Mount Lucas Management LLC expects the rally could be sustained up to $1.20.
But as he prepares to scour Powell’s key speech on Friday, Elias Haddad, senior markets strategist at Brown Brothers Harriman, says the euro is almost certain to pare its advance as the Fed eases less aggressively than the ECB.
“We continue to believe that the divergence story remains in place and should continue to support the dollar,” Haddad said. “Markets are overly pessimistic about the US economy.”
–With assistance from Anchalee Worrachate.
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