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If you’ve got the guts, Citi’s Steven Englander has a trade for you in Europe.There is an upside tail to the euro, despite our baseline view. There is overwhelming market pessimism with respect to euro zone outcomes. Positioning is euro negative but not as extreme as sentiment. Spreads in much of the euro zone are at levels that are unsustainable over the long term, but have the making of a tremendous convergence trade if the ECB ever decides that enough austerity is in place to justify buying bonds in size. The timing is difficult to predict, but with sentiment so negative, some low delta out-of-the-money upside exposure in FX and Fixed Income (FI) markets can be justified. Both official and private clients remain concerned about the USD, given the prospects for low yields and fiscal uncertainty, so it would not take much to swing them out of the USD. Given the record in recent years, sustained, aggressive buying by the ECB would benefit the EUR more by risk reduction than it would hurt through lost credibility. It’s clearly not yet what the ECB wants to do, but if they do it in the big bazooka way, there will be a convergence trade that would help austerity, growth and debt sustainability. As a footnote, most clients see ECB buying as a euro positive, because they feel the contractionary forces are severe in the best of outcomes, although a decent minority see ECB buying as euro negative because of the perceived inflation risk.
Basically, all those spreads we keep talking about — Italy-Germany, France-Germany, etc. — have the potential to come in violently on the chance the ECB acts. The ECB might not act, but it might be worth an outside bet that it will.