Date: 24 Jul 2017

“History doesn’t repeat itself but it rhymes,” a quote often attributed to US author Mark Twain, may be an aphorism euro bulls wish to bear in mind.  Parts of the sell side of the market are beginning to articulate arguments for yet more euro appreciation. French bank Societe Generale feels “there are echoes of 2012-2014 in the way EUR/USD is trading, and they suggest it may be at $1.20 by the time the ECB meets again in September.” In SocGen’s view the “EUR/USD continues to move higher in tandem with narrowing yield differentials between the US and the euro area” but that the euro is now “moving ahead of the yield differential.” But is that a concern?  SocGen has also identified a “re-correlation between EUR/USD and peripheral yield spreads, the euro’s rally since European political risk depreciated being matched by a sharp tightening in the Bono/Bund spread.” SocGen argues that “was the norm in 2011-14, before the ECB introduced QE/NIRP when the correlation between rates and currency was made complicated by a correlation with spreads.”

SocGen’s view is that “Mr Draghi’s ‘Whatever it takes’ speech in 2012, in particular, reversed the widening we had seen in spreads, and that sent EUR/USD to 1.40.” Cutting to the chase the French bank contends that “a return to a significant correlation between spreads and the currency would make sense once the QE era ends. If it has already happened, we shouldn’t expect this EUR rally to run out of steam very soon.” Whether traders are convinced by SocGen’s arguments will be a matter of personal choice, but there’s arguably another issue at play here. As discussed in Friday’s piece, and unlike what happened with the “Whatever it takes” speech in 2012, the euro’s reaction to last Thursday’s Draghi ECB press conference was arguably driven by what the ECB Chief did not say rather than what he did. If institutions, such as SocGen, now begin to articulate euro-bullish arguments that complement perceived market sentiment, euro bulls may become even more emboldened.

Written by Neal Kimberley, External Currency Analyst.