Citi: EUR/USD Risk/Reward Favours EUR Upside

Ahead of the key December meeting of the ECB the EURUSD 'short' trade is overcrowded and primed for a correction suggest CitiFX.

Chasing the euro exchange rate complex lower has been a favourite trade over recent months as the break of the 1.10 support zone was seen as an open invitation to target levels towards 1.05.

The strength of the move lower has been exacerbated by developments at the European Central Bank which is widely tipped to cut rates and expand its asset purchase programme in December.

However, strategists at the world’s largest foreign exchange dealer, Citibank, now believe the risk / reward ratio pay-off now favours betting on a euro recovery.

The size of the recovery would however be ‘moderate.’

The strategic call comes in the wake of reports that ECB members are discussing whether to impose 2-tiered charge on banks for deposits with the ECB. In fact there are said to be up to 20 options being considered.

Importantly though, currency traders must be aware that there is dissent in the ranks with ECB governing council member and Estonian central bank governor Hansson sticks to the view that the ECB doesn’t need to cut policy rates now as growth and inflation develop largely as expected and recent data has surprised to the upside.

Nevertheless, markets have priced some aggressive ECB action into the exchange rate:

“Levying a bank charge (albeit 2-tiered) effectively amounts to a deposit rate cut from the current -20bp that appear largely discounted into Euro zone short rates cut at next week’s meeting. So if the deposit rate cut is the only easing measure announced next week, EURUSD could potentially bounce,” say CitiFX.

Citi believe recent price action that saw EURUSD slump to a 1.0566 low post the Reuters headlines is noted for its brevity and the imbalance to sell EURUSD by the leveraged segment only.

“The 1.0600 area provides initial support followed by 1.0550 and 1.0520 while 1.0728 & 1.0765 are seen as decent resistance levels,” say Citi strategists.

Don't be Scared of the Short Squeeze

Don’t be scared of the ‘short-squeeze’ higher say ING.

ING acknowledge that while there may be push-back from a few of the ECB dissenters over coming days, creating the risk of a EUR short squeeze, Draghi’s track-record over the last two years has been excellent and EUR/USD rallies should be sold for a move under 1.05.”

Meanwhile, the EURGBP was far more aggressive in its decline, slumping back towards recent lows after the pound had suffered earlier in the week on the back of BoE MPC members being a little more dovish than perhaps expected.

While the euro was being pressured lower the pound exchange rate complex was being bought as markets welcomed a positive set of growth and spending forecasts set out by the UK’s Chancellor of the Exchequer George Osborne.

“The price action in the pound surprised us as the rates market is already priced for no rate hike in the UK until the very end of 2016/early 2017,” note Lloyds Bank.

We see chasing the euro / pound exchange rate much lower as being a particularly hard ask as the pair is sitting just above a formidable inter-year support zone.

A survey of the world’s leading forecasters are also seeing limited downside based on fundamental studies with the average forecast for the exchange rate in 2016 sitting at 0.6944.