I noted in my Macro Wrap this morning the unexpected reaction of the EUR/USD currency cross to the Yellen nomination news:
The Euro has been a bastion of strength in an otherwise choppy market over the last 3 months. The EUR/USD cross has rallied from below 1.28 to above 1.36 in that period, quite a move for a currency with an implied volatility of only 8. A good portion of that rally has been caused by the continued dovishness from the Fed. No taper, no Summers, and now Yellen. Yellen’s nomination, while expected, is the last piece of the puzzle for QE as far as the eye can see. But despite that dovish news, the EUR/USD cross reversed overnight, and the Euro is actually lower against the dollar.
Here is the overnight price action, with the green arrow the move right after the announcement, and the red arrow the retracement since then:
EUR/USD intraday, Courtesy of Bloomberg
This is one of those moves in financial markets that immediately catches my attention. When news comes out that should cause an asset price to move one way, but that asset price moves the other way, that’s usually a great indication of the future path of least resistance for that asset. In other words, if the Yellen announcement can’t even get EUR/USD to go any higher from here, then EUR/USD is likely going lower.
The Euro has been stubbornly strong for months now, so the structure matters a great deal on any short Euro position. Most short Euro trades have been taken to the woodshed, which might be why positioning seems overly long Euro at the moment. On top of that, the 3 year weekly chart is a total mess:[caption id="attachment_31117" align="alignnone" width="600"] EUR/USD weekly chart, Courtesy of Bloomberg[/caption]
The EUR/USD is essentially at the mid-point of its 4 year range between 1.20 and 1.50. For all the focus on this exchange rate, it’s been a story of mean reversion for years now.
I had some success shorting the Aussie Dollar (see here) and the Canadian Dollar (see here) vs. the U.S. dollar this year, but the Euro has been painful for me in 2013 (this trade recently expired worthless, and I am still long UUP stock). However, the Euro’s strength due to Fed dovishness could finally be over, based on today’s reversal despite the Yellen announcement.
TRADE: FXE ($133.70) Bought Jan14 133/128 Put Spread for $1.35
-Bought 1 Jan14 133 Put for $1.95
-Sold 1 Jan14 128 Put at $0.60
Break-Even on Jan14 Expiration:
Profits: Between 131.65 and 128, make up to $3.65, max gain of $3.65 at 128 or below
Losses: Up to 1.35 btwn 131.65 and 133, with max loss of 1.35 above 133
Trade Rationale: FXE’s low in 2013 has been between 126 and 128, which it has touched on several occasions. This structure plays for a move back to those lows over the next 3 months. The Euro’s move lower today could be a major turning point, and implied volatility is quite low, making a put spread attractive.