The euro has sold off sharply in recent weeks (by ~7.7% against the US dollar since late September, see fig 1a). In part, that reflects heightened concerns about the impact of US tariffs on Europe, as well as fears of a German recession (amongst other factors).
The key question, therefore, is: Has the “bad news” been priced in? Or is there more downside ahead for the euro? From a positioning perspective, the market is net short. As fig 1b shows, that usually doesn’t happen outside of a Eurozone-wide recession. It’s therefore a strong contrarian BUY signal. In a similar vein, euro sentiment is bearish (also a contrarian BUY signal), while our key euro market timing models are back on BUY (fig 1c). As such there’s plenty of fuel for a rally in the euro.
Of interest, in that respect, the sell-off in the euro has not been confirmed by the behaviour of relative interest rates (between the US & Europe). Usually, a falling euro is accompanied (driven) by lower German Bund yields relative to US yields. That hasn’t happened this time (fig 1). On that basis, therefore, the euro is over-extended to the downside (and likely to rally).
Risks as always are multiple. Trump is expected to sign several ‘Executive Orders’ (post today’s inauguration). If those orders are more draconian than anticipated, the dollar should strengthen further. Likewise, if they’re softer than expected, then a tactical relief rally in the euro is likely (and crowded short positioning should unwind).
Fig 1: UST-Bund 5-year yield spreads (inverted, bps) vs. EURUSD spot price
Fig 1a: USD-EUR candlestick futures, shown with 90 & 200 day moving averages
Fig 1b: Net speculative positioning (no. of contracts) vs. EUR spot price (inverted)
Fig 1c: EURUSD Market Timing Model vs. EUR spot price
