Tommy Wilkes and Saikat Chatterjee

LONDON, (Reuters) – Investors have begun to invest in derivatives that are linked to a rising Euro, according to data from the industry and trading sources. They believe the European Central Bank’s hawkish bias will end eight years of negative rates.

Since the ECB announced that it would open the doors to a rate rise later in 2022, the euro has risen three months to $1.15.

Christine Lagarde (ECB President) has taken a more dovish tone since then. However, traders feel that the shift is apparent and markets should catch up to an ECB ready to tighten — even if they aren’t as quickly than their rivals.

“There were not many things priced in the euro, and people are forced to consider the ECB’s potential tightening. German inflation has reached a very high level,” Antony Foster, Head of G10 spot Trading, EMEA at Japanese bank Nomura, said.

A significant moment would be marked for the euro area markets that have been suffering from persistent outflows as well as currency weakness, that analysts attribute to rates below 0%.

Hedge funds love to use the euro to do lucrative carry trades, which is borrowing in low yielding currencies and investing in high-yielding currency.

According to Refinitiv data, a strategy that borrowed euros and invested them in U.S., Australian, and sterling earned a 5.3% return last year. This is the highest rate since 2015.

Citibank’s head of European FX Strategy, Vasileios Gionakis said that people no longer view the euro as an inexpensive currency for borrowing.

He said that the ECB’s decision “changed everything for the Euro.” “While we don’t expect the euro and rest of the world yield differential to shrink dramatically, it is a big change in sentiment.”

Foster from Nomura said clients were buying large amounts of euro call options. This gives traders the option to buy future euros at predetermined prices, ranging between 1-month maturities and 1-year.

These include call options against the euro/dollar and euro/Swiss franc, as well as the sterling which was at its highest level in two years compared to the single currency prior to the ECB meeting.

“The BoE seems like it moved earlier than expected and this has been priced. Foster said that there is still a lot to be done in euro pricing. He was referring to Bank of England rate hikes this month and December.

Data from the industry shows that there is now a shift in positioning of derivative markets for euro/dollar. A currency pair that was stuck in tight trading limits since 2015 frustrates bank traders, who profit more from lower volatility.

Risk reversals of euro/dollar over three months, which is a ratio between calls and puts on one currency, bounced this week from -0.7 to +0.2, their highest levels since July.

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Some people are not bullish about the euro. Thursday’s U.S. inflation forecast that beat the market is a sign of markets again betting on tighter US economic conditions.

Analysts from HSBC say that the United States is experiencing higher growth, and high inflation. This justifies “persistently tightening”, whereas raising euro zone rates would not help to end its stagflation.

The Eurozone labour market has more flexibility to absorb workers than wage pressures, and ECB policymakers can easily revert back to their decade-long dovish position if inflation drops.

The ECB is also going to be cautious about any hawkish pricing, which could drive up borrowing costs in countries like Italy or Greece. This month has seen an increase in government bond yields.

Commodity Futures Trading Commission data indicates that the number of long positions in euro futures markets for speculative euros has not increased over recent months. However, economic data from the region is improving.

It also means that the euro will have to rise further if there are changes in positioning.

Goldman Sachs (NYSE 🙂 said this week that the euro/dollar “fair price” was $1.30

Goldman’s analysts suggested that faster Fed rate rises may hold the euro back in the short-term. But they raised their annual euro/dollar forecast to 1.20 from the previous $1.15. A further increase to $1.25 was predicted for 2023. And $1.30 is expected at 2024.

(Graphic: https://fingfx.thomsonreuters.com/gfx/mkt/zjvqkagknvx/euro%20and%20CFTC.JPG)