(Bloomberg) — After the euro’s best month since 2010, traders looking to a traditional rally at the end of the year may be disappointed.
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History shows that the coin tends to appreciate against the dollar in December. But after gaining more than 5% in November, the benchmark for seasonal cheers is much higher.
That’s even before investors consider a host of macroeconomic obstacles for the region as it prepares for a potential energy crisis this winter. Some big central bank meetings are also needed, and euro bulls have a lot of risk to navigate.
Derek Halpenny, head of research at MUFG, said: “The seasonal euro trend is strong but the rally in October and especially November could mean the move has started early. than usual”. 2023. “The fundamentals for a sustained sell-off of the US dollar are not quite ready yet.”
The euro spiked last month on bets that the Federal Reserve would slow down its hiking campaign to weaken the dollar and investors speculated China would reopen its economy. Some data showing that the eurozone’s recession has slowed has also raised hopes that a widely anticipated recession could turn out to be less severe than initially feared.
Seasonal currency trends are often dismissed as mere coincidence, although the time-specific cash flow argument makes more sense for December. That’s when investors close positions when Liquidity evaporates heading into the holiday season, while European year-end reporting requirements could trigger repatriation cash flows.
The euro has appreciated on 15 of the 23 December since its inception. That means an average gain of 1.5% — more than double the next best month.
Simon Harvey, head of currency analysis at Monex Europe, said the historical performance could be partly a by-product of negative European interest rates. There will be capital outflows out of Europe as investors seek higher-yielding assets elsewhere, only to have those capital flows back home during the year-end reporting period.
But now the market is grappling with a new inflation regime and higher interest rates.
“This year is going to be interesting for two reasons: dollar strength has been curtailed throughout November following the October CPI announcement, and the ECB has come out of negative rates.”
Risks could increase by mid-month, when the European Central Bank and Federal Reserve are expected to slow the pace of rate hikes. If the Fed continues to flag high inflation risks, that could drive investors back to the dollar at the expense of the euro. Other clues to inflationary pressures could come from next week’s data on US producer prices, jobless claims and sentiment.
“Given the key central bank decisions in mid-month, when liquidity starts to weaken, the euro correction still remains to be seen,” said Jeremy Stretch, head of G10 forex strategy at CIBC in London. is a real risk”.
Weather is also increasingly seen as a major threat to the currency’s interests. There are signs that temperatures are about to drop in Northern Europe, testing the region’s winter readiness amid supply constraints since Russia’s invasion of Ukraine.
That is a risk acknowledged even by euro bulls like Nomura strategist Jordan Rochester. He expects a rally to $1.08 by mid-December before $1.10 is reached in late January. He concedes that seasonal trends must be taken “seriously.” ” and sees weather and energy prices as the main risks to its call.
“We are not going to put the issue of seasonality alone. Instead, it could be macro factors and flows that determine the price action over the next four weeks,” he said, citing more positive European economic data and the inflow of funds into swaps. EUR portfolio. “We will need to keep a close eye on weather forecasts and natural gas futures.”
According to Brad Bechtel, forex strategist at Jefferies in New York, currency volatility in any direction could be exacerbated by diminishing liquidity ahead of the year-end holiday season. Moreover, exchanges this year may also be postponed by the matches of the soccer World Cup, which will end a week before Christmas, he added.
“That could mean moving to 1.10 or even parity,” he said, adding that a move to 1.00 is a more viable option, as he expects that The dollar sell-off will ease this month.
–With support from Vassilis Karamanis and Libby Cherry.
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