(Bloomberg) — With the European economy lurching toward a recession, traders are growing more convinced that the euro breaking parity with the dollar is imminent.
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Shorting the euro is one of the most popular trades in the market, and strategists from Nomura International Plc to HSBC Bank Plc have told clients to expect more losses ahead. According to Bloomberg’s options-pricing model, there’s around a 50% implied probability of the currency hitting parity versus the dollar in the next month.
With the euro at a 20-year low, investors are grappling with the possibility that Russia may cut off gas supply to Europe and plunge the region into recession. The economic shock would make it harder for the European Central Bank to raise tighten monetary policy, and likely widen the interest-rate differential with the US. The common currency slumped further Wednesday, trading as low as $1.0187.
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“It’s all about Russia,” said Kaspar Hense, a senior portfolio manager at BlueBay Asset Management. “If we see oil rationing in Europe because of a cut in Russian supplies, we will see a significant recession in Europe. It could be a very long winter.”
Hense said that BlueBay has been shorting the euro since last month. He expects the common currency to slide to 90 cents versus the dollar if Russia withholds supply, though it’s not their base case.
German officials have been voicing concern that a key pipeline delivering Russia’s natural gas to Europe may not return to full capacity after planned maintenance this month. The International Energy Agency has warned that a complete cutoff in flows “cannot be excluded” given Russia’s “unpredictable behavior.”
Tim Brooks, head of FX options trading at market maker Optiver, is expecting more volatility if the euro breaks through dollar parity. Demand for euro options is coalescing at lower levels from about 0.92 to 1 versus the dollar, he said. Nomura International Plc strategist Jordan Rochester wrote on Tuesday that he has even more conviction in his call that the euro will slide toward 0.98 by August.
The euro “remains effectively unbuyable this summer,” said Kit Juckes, chief global currency strategist at Societe Generale. “Europe’s energy dependency on Russia is falling, but not fast enough to avoid recession if the pipeline is closed. If that happens, EUR/USD will likely lose another 10% or so.”
There’s also the additional worries about wide Italian bond spreads, said Van Luu, head of currency and fixed income strategy at Russell Investments.
“It’s a perfect storm for the euro at the moment,” said Luu, who holds a small short position. Still, the currency is already at weak levels and there’s a good chance it could strengthen in the next year, he added.
“I wouldn’t rule out parity given the cocktail of factors, but personally I wouldn’t chase this move,” he said. “I wouldn’t add to euro shorts at the moment.”
For months, the euro has been dogged by the view that interest rates in the euro zone will lag aggressive tightening in the United States. Traders are also expecting less overall tightening as well because of the region’s feeble economy.
“A lot of capital has flowed into the US, but unless there is something enticing it outwards then the dollar can stay strong,” said Andy Bloomfield, head of macro research at Record Currency Management. “For it to be enticed outwards you need to see a better economic outlook in Europe and other places.”
(Updates with Societe Generale ‘unbuyable’ view in eighth paragraph.)
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