DBG - Key Trends in the Foreign Exchange Market

Hedge fund bearishness on the euro is at its highest level since the start of the year ahead of the European Central Bank's monetary policy meeting this week and the release of blockbuster economic data such as CPI and retail sales in the US. The latest data from the US CFTC showed speculative traders held a net short position in the euro on 6,421 contracts last week, in sharp contrast to the previous week's net long position.

Hedge fund bearishness on the euro is at its highest level since the start of the year ahead of the European Central Bank's monetary policy meeting this week and the release of blockbuster US economic data such as CPI and retail sales.

The latest data from the US Commodity Futures Trading Commission (CFTC) shows that speculative traders held a net short position in the euro in 6,421 contracts last week, in sharp contrast to the net long position in the previous week.

In addition, long-term asset managers have also reduced their net long positions in the euro.

Markets remain divided over the likelihood of another ECB rate rise as bets - currently at 60 per cent - have been rising on the ECB to pause interest rate rises, even as fears mount about the eurozone's deteriorating growth outlook.

DBG ForexSince the start of the interest rate hike process in July last year, the European Central Bank has raised interest rates 9 times in a row, with a total of 425 basis points.

Carsten Brzeski, global head of macroeconomics at ING Groep NV, said: "Whether to pause or continue to raise interest rates, the outcome is unpredictable. It's almost like flipping a coin."

"Stagflation in Europe is a real risk," said Mark Dowding, chief investment officer at RBC BlueBay Asset Management, who is long the dollar against the euro. "Growth has been disappointing but there has been limited progress in reducing core inflation."

Iain Stealey, chief investment officer for fixed income at JPMorgan Asset Management, said: "Our baseline forecast is that the ECB as a whole will pay more attention to economic growth data and will view this meeting as a pause."

Sentiment around the euro has worsened

Sentiment around the euro deteriorated throughout the summer, and in fact, the euro/dollar pair has fallen for eight straight weeks, retracting more than 4 per cent from its July peak.

According to Bloomberg, hedge funds cut their net long positions in the euro by nearly 90% in August.

The outlook for the eurozone economy is rapidly darkening. The European Union Commission on Monday downgraded its growth forecast for the region, now predicting output growth of 0.8 per cent in 2023, down from a previous forecast of 1.1 per cent. Next year's forecast was similarly revised down to 1.3 per cent.

The European Central Bank recently released data showing that the euro zone's money supply contracted in July for the first time since 2010.

Driven by the general weakness of the dollar, EUR/USD rebounded on Monday, rising 0.41% to 1.7043 on the day.

However, ING strategist Francesco Pesole warned that any rebound in the euro was likely to be short-lived.

Mr. Pesole noted that a stronger-than-expected US inflation reading this week would help the Federal Reserve keep interest rates high to support the dollar, while ECB policymakers "clearly face growing divisions" as the economy slows.

"Given the upside risk to the dollar ahead of the release of the US Consumer Price Index (CPI), we suspect that the EUR/USD will most likely fall below 1.07 again ahead of the ECB's interest rate decision on Thursday," said Mr. Pesole.

In addition to Wednesday's CPI, the U.S. will also release the latest producer price index (PPI) and retail sales data on Thursday.

Win Thin, global head of currency strategy at Brown Brothers Harriman & Co., said: "It's dangerous to short the dollar ahead of this week's data."