EUR-USD made a dip to lower ground only to recover. What’s next? Parity should not be ruled out.
The team at Deutsche Bank explains why shorting the pair is the way to go:
Here is their view, courtesy of eFXnews:
In a note to clients today, Deutsche Bank argues that there is a new reason for traders to stay bullish on the USD and expresses that via EUR/USD short positions. According to DB, a new dollar-supportive driver is emerging beyond the widely understood central bank divergence story: the rising cost of dollar funding.
“Over the last few weeks the cross-currency basis, representing the additional cost of borrowing dollars in the FX swap market over and above the rate differential, has ballooned to the highest since 2011,” DB notes.
DB outlines 4 important nuances to this phenomenon that are worth mentioning.
“First, the widening is happening against multiple currencies, in contrast to previous episodes that have been mostly focused on the yen or euro.
Second, widening basis does not seem to be driven by rising credit risk, similar to Lehman and the Eurozone crisis. Alternative credit metrics such as the USD Libor-OIS spread have remained very well-behaved.
Third, the move seems to go beyond traditional year-end funding constraints because even longer-dated cross-currency basis has widened out.
Fourth, the cross-currency basis move is coming at a time when US rates are rising for the first time since the end of the financial crisis while everyone else is at zero. This matters because the low starting point of rates means the proportionate impact of a widening basis on the rate differential can be big,” DB clarifies.
“Overall, a combination of year-end funding constraints, lack of liquidity, regulatory pressure nd precautionary demand for dollars ahead of FOMC liftoff seem to all be driving the move in the basis
…This adds to the bullish dollar view, on top of the fact that traditional metrics such as the real rate differential already point to a move down to parity in EUR/USD,” DB concludes.
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