Euro Strength Ahead? How US Investors are Propping up the Exchange Rate

US investors are turning more bullish on the euro reports a leading investment bank.

This pro-EUR observation comes at a time when the majority of analysts continue to predict a substantially weaker euro exchange rate complex over coming months.

Indeed, our cumulative forecast tables note that the euro to dollar exchange rate is widely tipped to reach parity while the pound to euro exchange rate tables are predicting at least 1.45 to be achieved.

There is however an idea being forwarded that swims against the flow.

UniCredit Bank have told clients that there a signs that the outlook may not be all that bad for the euro.

Over the past few weeks, UniCredit’s Dr. Vasileios Gkionakis has made the casual observation that the euro has been more supported during New York trading than during the Tokyo and London sessions.

This dynamic was exposed brutally on Monday the EURUSD fell to 1.0969 in Asia only to be bid to a high of 1.1278 by the US close.

The euro to pound exchange rate meanwhile hit a low of 0.6989 to peak at 0.7167, a remarkable intra-day move.

“Anecdotal evidence from discussions with clients in the US suggests to us that many US investors subscribe to our view that too much is priced into the US dollar,” says Gkionakis.

UniCredit’s team put this view to the test:

“Regressing daily EUR-USD and DXY returns of the past month on two dummy variables for the different time zones, we find statistical evidence supporting our hypothesis.

“Our analysis shows EUR-USD returns during NY trading hours are positive (and DXY returns negative) and statistically significant at the 10% level.

“This suggests US investors are more inclined than their Asian or European counterparts to close out euro-pessimistic positions, reflected in the reduction of CFTC short positioning.

“Furthermore, we suspect the better performance during US trading hours may be driven by investors entering euro-optimistic positions, for example bringing currency exposure in international equity portfolios back to more normal, higher levels.

“This should lead to a revival of euro support assuming a positive outcome to the situation in Greece.”

With the European recovery on track for an acceleration of 0.4-0.5% qoq GDP growth in 2Q15 and further improvement ahead, UniCredit expect international investors to allow for a more normal amount of currency exposure to the euro, lowering hedging ratios to their usual levels.

One of the main drivers of recent euro weakness is a flood of global currency finding its way to Europe as investors pick up stocks that are expected to outperform thanks to European Central Bank (ECB) quantitative easing.

Usually this would boost the euro, but billions of euros were being simultaneously hedged on currency markets and this is why the exchange rate fell.

The cessation of this dynamic would prove EUR-positive.

"This should lead to a revival of euro support assuming a positive outcome to the situation in Greece," suggest UniCredit.