am/FX: EURUSD Information

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Talking about the trend in EURUSD and an example of efficient markets in action…

by Brent Donnelly

August 26, 2022

Current Views

Short ES1 @ 4272

Stop loss 4366

Take profit 4010

August 23, 2022

EURUSD information

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EURUSD has been trending lower all year as old support becomes resistance and rallies are sold, over and over. With baseline power making new highs across Europe today…

*FRENCH YEAR-AHEAD POWER TRADES ABOVE EU1,000/MWH FOR FIRST TIME

… There is no obvious end to what looks to me like a structural story that will play out well into 2023. That said, EURUSD has come a long way from the highs. Has it come too far to bother getting involved here? Not really.

Here is how much EURUSD has moved in other bear markets.

2-year peak to trough drawdown for EURUSD

2000/2002 was the US tech bubble inflows + existential EUR risk as there was skepticism on whether the EUR made sense when it was first launched (monetary union without political union = messy). 2008 was the Great Financial Crisis. 2015 was ECB QE. I would think the current trade balance shock + inflacession + Fed tightening trifecta is on par with those other stories in importance and severity.

EURUSD bottomed 25% to 30% off the 2-year high in those cases which would be 0.8644 / 0.9252. The calculation is off the 2021 high of 1.2349.

And if we look at oversoldness, EURUSD isn’t anywhere close to oversold vs. its 100-day moving average:

EURUSD deviation from 100-day moving average

The move has been orderly and has not attracted excessive speculative fervor so far.

Efficientish Markets

There is an interesting phenomenon in markets where a known seasonality tends to move to the left as the market front runs the effect. This has been happening with the real money flows around month end as everyone knows the model for month end moves in FX and so participants have been doing their hedging earlier and earlier. I covered the decline of the usefulness of month end models in “am/FX: RIP Month End Model” as the effect has moved earlier and been watered down as efficient markets eventually prevail.

On Tuesday, there was a huge EURUSD and GBPUSD buy flow into the 11 a.m. WMR benchmark as you can see here:

EURUSD 1-minute chart into 11 a.m. NY time on Tuesday

My guess is that the buyer was a central bank doing rebalancing. As spot falls precipitously, central banks become underweight a currency and need to buy to rebalance. Imagine a central bank with one trillion USD in reserves, and a benchmark allocation of 20% EUR and 80% USD. At 1.05 EURUSD, they are 20%/80% and thus have 800B USD and 200B EUR. If EURUSD drops from 1.05 to 1.00, they now only have 190.5B EUR and need to buy around 10B EUR to get back to 20%. Many central banks do this sort of rebalancing and often it happens over the course of several days. Therefore, after that huge spike on Tuesday, traders are geared up for the same thing to happen on Wednesday.

If you are a market maker and you’re short at 10:15 a.m., for example, you probably square up, just to be safe. If you’re a seller, you’re more likely to wait until 11 a.m. passes, just to be safe.

EURUSD 1-minute chart into 11 a.m. NY time on Wednesday

This is not particularly actionable; I just think it’s a neat example of efficient markets in action and also a good example of how EURUSD can move 30 to 50 points on no news on the back of a large flow.

Final thoughts

If you have seen the movie Snowcrash, you might find this a bit concerning:

https://finance.yahoo.com/news/china-deploys-rain-seeding-drones-003056794.html

Justin Ross is writing excellent non-fiction on his Substack. His latest is called “Being Limited Equals Being Free” It’s an outstanding 5-minute read; deep thoughts, interesting and funny.

Have a solved day.