The future of the euro: traders brace for more losses

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The future of the euro: traders brace for more losses

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The return of European lockdowns is sharpening the focus of euro traders on a key support level that dates back to the currency's inception more than two decades ago.

The common currency fell 0.2% to 1.1272 as of 7: 11 a.m. in New York, within 0.2% of a 16 month low. It hit that level after Austria said it will enter a nationwide lock-down and Germany hinted it may follow soon. The euro, which was already under pressure this month because of widening monetary policy and economic data divergences between Europe and the U.S. was dragged down by the announcements.

A downturn in European sentiment has led traders and investors to look for the next line in the Sands - $1.10, where a trendline has been in place since 1999. As traders see the European Central Bank keeping borrowing costs at a record low while the Federal Reserve moves toward raising rates, stratasts at UBS Group AG and HSBC Holdings Plc say they expect the euro to decline to that level by the end of 2022.

Citigroup Inc. strategist Ebrahim Rahbari wrote in a note that we are agnostic about the euro-dollar outlook this week, but would use any retracement to sell it.

There are signs of traders bracing for more declines across markets. Here is a look at some of these measures:

Demand for options that pay out if the euro falls, is the strongest it has been this year, according to Depository Trust Clearing Corporation data. The breakdown eight months ago showed that bullish wagers represent just 44.5% of the total interest for vanilla options this month.

According to November trading volume data on bearish bets from the DTCC, the euro holding around current levels between $1.13 and $1.14 may be as good as it gets for the currency.

Options traders only see a 22% chance of the euro falling to $1.10 this year, but the odds that it will happen in the first quarter of 2022 climb to a coin toss. According to Bloomberg's options pricing data, Traders think there is a 64% chance it will happen by the end of next year.

Pressure on the euro is due to the widening interest-rate and yield differentials between the U.S. and the euro area. The spread between two-year U.S. and German yields has widened 20 basis points this month to the most since March 2020. That compares to just eight basis points in March this year, when similar dynamics weakened the euro 2.9%.

As the outbreaks are getting worse, Europe is heading for tougher restrictions in many countries, according to Danske Bank analyst Mikael Olai Milhoj.

Australia New Zealand Banking Group Ltd. senior international economist Brian Martin noted that the euro may be vulnerable to downside risks, because growth and interest-rate expectations have swung against the euro area.

Vassilis Karamanis is a FX and rates strategist who writes for Bloomberg. The observations he makes are of his own and are not intended as investment advice.

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