Expert view: Where now for the euro?

The start of European Central Bank quantitative easing (QE) and the improvement in US data has provided something of a perfect storm for the euro, writes IG analyst Christopher Beauchamp.

A wave of selling has overtaken the currency and now all the talk is of the euro hitting parity against the US dollar for the first time since 2002.

It has a logical theory behind it. QE is not designed to weaken a currency per se, but the large-scale purchase of securities by a central bank does have that effect.

Increased reserves mean banks can loan more, flooding the system with ‘cheap money’.

Meanwhile, the US dollar’s appeal has been bolstered by expectations that the Fed will undertake the first tightening in monetary policy since the financial crisis.

US treasuries have risen as a result, on expectations that the US will enter a rising rate environment even as other central banks cut rates.

Over the past week analysts have rushed to predict that EUR/USD will drop to $1 during the course of the year and continue falling in years to come.

The ‘short euro, long dollar’ trade is now perhaps one of the most crowded in financial markets.

This opens the way to a possible ‘short squeeze’ should the euro begin to rally.

On a monthly chart, the euro is now showing its most heavily oversold reading since its creation, and even a short-term bounce could prompt a rapid short-covering operation that might result in the unexpected, a rising euro.

Next week’s Fed meeting is widely forecast to remove the word ‘patient’ from the statement regarding the time period before raising rates.

However, if the committee chooses to look beyond the positive headline numbers from the latest NFP report and instead concentrate on areas where the economy is weaker, then it may stay its hand even where this modest change is concerned.

The net result would be a pullback in the US dollar rally, leading to a move higher in the euro that could snowball as shorts are covered.

When everyone is predicting one outcome, the wiser course can be to ignore the crowd.

Christopher Beauchamp is a senior market analyst at IG Group.