Fundamental Forecast for the Euro: Bearish
- Speculative liquidity all but vanishes as fundamental backdrop continues to deteriorate
- Italian 2Q GDP figure kicks off a disappointing review for the Euro Zone
- EURUSD: What does multi-year low volatility measures mean for direction?
Whether the euro extends its month-long period of congestion or returns to the momentum and big swings of the past year depends on the level of speculative participation in the market. Volume is the market’s vital, missing element. Without speculative market depth, there isn’t enough of a market to feed relief rallies, reversals or wholesale deleveraging. The euro is perhaps the best positioned currency to enjoy a swell of activity regardless of the underlying level of risk trends thanks to a loaded economic docket. Yet, that volatility would likely prove fruitless for meaningful swings without an active shift in the market’s principle fundamental theme: risk appetite trends. That said, could the weight of the Euro-area’s economic health provide the necessary push to put the entire market back into motion…
Before we talking about catalysts, we should first appreciate how responsive the market would likely be with major speculative and fundamental sparks. If the market conditions that epitomized the slow, chop of this past week are to persist; headline-worthy event risk may be overlooked by a market that is incapable of capitalizing on the development. There are many different, potential measures for activity levels, but nothing that can wholly capture the broad liquidity of the market (oftentimes capital can drain from one security or asset class and relocate to another). That said, the S&P 500 is a good measure for general speculative participation as it represents a standard long-biased asset for one of the largest markets in the world – and it offers the stimulus view. From this standard bearer, volume this past week was the lowest (outside of holidays) since the late 1990s.
For the euro itself, aggregate futures volume (as there is no spot turnover figures) hit its lowest non-holiday trading level since May 2009. The expectations for participation are low as well. Implied volatility (expectations for market movement backed out of options) for the coming three months is just off of its lowest levels since August 2008. The fact that this level is historically similar to the one that preceded the worst global financial crisis in modern history does not imply that history will repeat itself. However, we have to question whether the risk levels that these measures entail accurately portray the economic and financial backdrop for the Euro Zone. While we may not be on the brink of collapse for the monetary union at the moment, the pain is still palpable.
What are particularly remarkable are the levels of risk that the market is pricing in for the week ahead. The one-week implied volatility measures for EURUSD have dropped to an incredible 8.19 percent. The measure may have been lower in March and April (just before a near-1000 pip tumble) but it is still in the extreme low end of its range going back to before the US subprime / Lehman Brothers crisis. Not necessarily unusual give the general backdrop, but extraordinary given the level of event risk next week.
A front-loaded docket this coming week will start off Monday with the advanced reading of 2Q GDP from Greece (no specific time is provided). As the region’s weakest link and the likely tipping point on whether the Union can survive in its current format or not, this reading will carry deeper implications than just extending the multi-year recession. Posting a ‘better’ figure than the 7.0 percent year-over-year contraction expected isn’t what matters here. It is reminding the market that austerity and appeasing collective rules for very disparate economies has a very real cost. The following day we will be inundated with periphery growth readings (Portugal GDP), measures of strength for the critical core (Germany, France, Euro Zone aggregate), a measure of market confidence for the debtors (Greece bill auction) and sentiment look for the creditors (German ZEW investor survey).
In reality, the economic malaise is already expected and no doubt represented in the level of the euro and regional asset prices. To make the critical jump for the data to play the role of short-term catalyst for the euro to a catalyst for underlying risk appetite trends (one of the few foreseeable waves that can actually reach that threshold this month), the growth troubles for the largest collective economy need to reignite fear in the world’s most pressing financial crisis in the region’s sovereign and banking credit risk. Not only would the stability of a critical player in the global economy threaten disruption, but fear that a credit crunch will spread would set the financial world alight. –JK