EUR/USD is stuck in a range for quite some time. Will it make a move? Here is what could change it:
Here is their view, courtesy of eFXnews:
The correlation between the currencies and equities of European countries has increased sharply since the Brexit vote (Chart of the day). This may be due to the perception that unpredictable European politics make for inconsistent capital markets, causing investors to shift their allocations elsewhere.
Indeed, we find evidence of European outflows benefitting emerging markets. In our view, the rise in cross-asset correlation may signal a paradigm shift for EUR. For international investors, strong positive FX correlation to equities implies accepting greater volatility to hold European assets. From a risk-management perspective, hedging currency exposure when owning positively correlated assets can improve volatility-adjusted returns. This suggests that EUR puts should command a greater premium than is currently implied by the market, which is why we see value in buying risk reversals.
Mispriced options skew When we highlighted EUR as behaving like a “safe haven” last August, we simultaneously identified selling EURUSD skew as an attractive trade. Since then longdated skew flipped from favoring EUR puts to EUR calls (Chart 3). However, we now see an attractive opportunity in buying EURUSD skew.
Going forward, we expect EUR to trade like a risky currency. We now expect EUR depreciation to be associated with higher volatility events. On the other hand, should EUR appreciate, the European Central Bank could be more active in suppressing further strength, dampening volatility in scenarios where EUR strengthens.
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