The EURUSD pair was the star of the last few months in the FX arena. It stretched higher than 1.19 and triggered stops across the board. However, at the current levels, a higher Euro is not only a burden for the Eurozone, but also a strong contender to the USD dominance.
The investing community seems to have turned its back to the USD. Global hedge funds bet on a decline of the dollar as the aggregate bearish bet on the USD rose by over $5 billion only in the last week. It is the largest overall USD short position since April 2018.
USD Liquidity Continues to Shrink
What is curious is that the EURUSD strength came at a time when the USD liquidity was actually shrinking. While the Fed prints plenty of USD, the Chinese central bank ends up building FX reserves and buying Treasuries.
The Treasury General Account (TGA) held at the Fed reached $1,800 trillion. The problem with this USD “bazooka” is when and if it will be deployed. More precisely, during the last months, while the Fed printed USD, the Treasury issued debt at an even faster pace.
With the US elections due, it may be that the Treasury will use the USD on hold as a stimulus for the economy. But if it does not, and, more importantly, if the market views the increase in the TGA account as something set to continue, the EURUSD fortunes will reverse.
For those not used to the way the EURUSD moves, the chart above offers a relevant perspective. The red point is from the last week and reflects the EURUSD versus the five-year swap rate differentials since 2004. In other words, while the market move seemed extreme, it is not something unusual for the EURUSD pair.
Last week’s GDP numbers revealed the economic disaster left behind by the coronavirus crisis in Europe and the United States. The QoQ data showed the United States faring much better than the Eurozone -9.5% in the United States versus -12.1% in the Eurozone.
Moreover, in the countries most affected by the virus (i.e., Italy and Spain), the GDP shrank -12.4%, respectively -18.5%.
However, despite the Spanish economy falling off a cliff, the Italians will receive more money from the recovery fund than the Spaniard – despite the recovery fund being built to fight the coronavirus economic recession.
Heading into August, the EURUSD seems elevated at 1.19. To still bid for it at such levels, investors ignore bearish fundamentals piling up against further EURUSD advance.