Despite the presence of record short-euro positions right now, Morgan Stanley’s Stephen Hull believes that any euro rally, perhaps due to a short squeeze, is ultimately a sucker rally.
Overall, while fiscal policy might be on a more credible path the biggest threat to the euro is now coming from monetary policy. We believe we are not far away from a point in time when the ECB starts printing and effectively monetising euro area debt. We revert back to our “punish the printer” theme, where quantitative easing remains negative for a currency.
The above comes at a time when the US economy is in good shape and growth is surprising to the upside. While the Federal Reserve used the printing press a year ago we expect them to begin reversing this process through the summer, while it might be that the ECB is boosting its money supply.
It is likely that any rally in the EUR will be relatively shallow. The combination of fiscal credibility and a likely move to quantitative easing should put pressure on EUR to depreciate. Near term, there may be a relief rally, due to positioning and a removal of the extreme negative tail risk, but the lower trajectory remains in place.
Europe’s printing press will firing up just as the Fed’s is winding down.
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(Via Morgan Stanley, EUR Tail-risk Curtailed, Trajectory Solidified, Stephen Hull, 10 May 2010)
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