Buying EUR/USD short-term upside is our top contrarian trade in the year ahead.
It looks much less controversial after the ECB disappointed last week
and the Euro squeezed higher. Although we remain bearish EUR/USD in the
long term and expect it to weaken to 0.95 by end-2016, our year-ahead
report saw upside risks in the short term. The short EUR position ahead
of the ECB meeting was not as stretched as it was last March, but it was
getting close. Indeed, the price action after Draghi fell far short
from market expectations reflected a painful positioning squeeze. Short Euro remains the most crowded trade in G10, suggesting further upside risks in the short term.
Moreover, a dovish Fed hike, or a risk-off market reaction to the
first Fed hike and a sell-off in Eurozone equities could push EUR/USD
higher. This is in fact in line with historical performance that has
seen USD trade lower four out of the past five times the Fed began a
tightening cycle (Chart 1).
Our year ahead recommended buying a EUR/USD 3m 1.10 call with a 16th Dec 1.1050 window KO. This trade is already in the money following the upward EUR positioning squeeze after the ECB disappointed last week. We will revisit this trade after the FOMC.
