Why EUR Is Not A ‘Surrogate’ For Bearish GBP Trades?

Following the big Brexit, EUR/USD fell but at a much lower scale in comparison to the pound. What’s going on? The team at Morgan Stanley explains:

Here is their view, courtesy of eFXnews:

Looking for bearish ‘quasi GBP’ trades makes sense, but focusing on EUR is wrong.  We do not disagree with views citing the risks related to the upcoming Italian referendum voting on Senate reform in Italy in October, a potential populist backslash when France holds its presidential election in April/May 2017 or the Netherlands seeing its right-wing ‘Freedom Party’ pressing for a referendum.

A world being long EUR-denominated assets on an FX-unhedged basis would see EUR selling aggressively lower. However,  currency hedging has been the name of the game for existing and new EUR-denominated positions  of non EUR-based investors since May 2014.There are fewer EUR-denominated assets within foreign portfolios than historically.Even more important is the state of EMU’s financial institutions not being allowed to put on additional balance sheet risks.

The Italian sovereign propping up Italian bank equity may allow share markets to rally, but it should not change banks’ cautious approach adding to its portfolio of foreign asset holdings.

Insurance companies face similar pressures.  The problem seems to be that there is good reason to be short EUR, but there are no sellers of long-term EUR-denominated asset holdings. Hence, EUR trades stable.

*Morgan Stanley maintains a long EUR/GBP from last Friday NY’s close from around 0.8119.

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