GBP/EUR Conversion Crashes as German Bund Sell-Off Sends EUR Higher

Why is the pound sterling falling against the euro once again?

The answer lies with the value of German debt. Bunds, the borrowing vehicle of the German government, have plummeted in price over the past 48 hours. [Update: Pressure on GBP at start of the new month driven by a shockingly poor Manufacturing PMI release.]

The basic dynamic to consider is this when wondering how all this works: Bunds up = euro lower. Bunds down = euro higher.

We see this as the prime cause behind the recent decline in the pound to euro exchange rate (GBP/EUR).

The question now concerns where the currency pair is headed next; we explore this question in today’s piece.

The Euro is Having a Good Run

Core Eurozone bonds were under sharp downward pressure during the European session; as we mentioned falling bond prices tend to support the Eurozone’s currency.

“In Europe markets have taken a beating after investors revolted against negative bond yields by selling them en masse - wiping €55bn off the value of Eurozone government debt,” says Augustin Eden at Accendo Markets, pointing out that some in the markets may be awakening to the absurdity of investing in a product that actually costs you money.

Germany’s Bund headed south with a number of potential drivers behind the move according to KBC Market’s Piet Lammens:

“Stronger EMU/German data, the sell-off of Swedish bonds despite more QE by the Riksbank, a failed German Bobl auction, huge supply and renewed hopes on a Greek deal.”

The German curve bear steepened with yields 3.5 bps (2-yr) to 15 bps (30-yr) higher.

“According to trading desks, the absence of real money buyers, a result of stratospherically high prices driven by ECB activity, led to a violent selling from trading books,” says Lammens.

So until we get some stablisation in the cost of German debt we are likely to see the euro continue to make gains.

Traders Reduce Bets Against the Euro

Another driver of euro strenght to consider is the squeezing of 'euro shorts' across the board.

A 'short' position refers to a speculative trade that looks to profit on the fall in the euro.

The failure to make fresh lows despite ongoing uncertainty regarding a Greek exit has seen a massively short market take profit on their bets against the euro.

Taking profit means euros must be re-bought to close the trading deal. This demand for euros has pushed the shared currency higher against the pound sterling.

Once the market heads back to equilibrium we would expect strength to subside.

The Outlook for Sterling v Euro

What does all this mean for the forecast?

The above graphic representation shows that momentum has been in the pound’s favour against the euro since the start of April when the support zone at 1.36 successfully resisted further EUR advances.

Momentum was confirmed when the GBP-EUR broke above the 20 and 50 day moving averages, represented by the green and grey lines above.

Traders often use such signals as solid confirmation that a turner has been turned and further gains lie ahead.

In a self-fulfilling prophecy further gains came as more traders bought the recovery story.

However, we now note that the pound sterling is slipping below these moving averages. This confirms to us that momentum is now slipping in favour of the euro.

While we can’t say for sure where the currency pair is going our best guess would be that the next level of support is back at the trust 1.36 area.

Take note that should volatility spike in the wake of the UK general election on the 7th of May all rules will be thrown out of the window.

We would expect any disturbance to be temporary however.