Traders Turn Optimistic on Euro With Stimulus Relief Mounting

(Bloomberg) -- Barely a fortnight ago, currency traders were fretting over the future of the euro. They're now cautiously optimistic.

The common currency just had this year's best monthly advance after the European Union finally managed to assemble a stimulus plan to steer the region's recovery from the pandemic. Option-market sentiment is improving and strategists are beginning to relay a glimmer of optimism on the euro's prospects.

The median euro-dollar forecast for third quarter edged up in May, the first positive change this year, according to a Bloomberg survey. HSBC Holdings Plc lifted its year-end call to $1.10 last week, from $1.05 previously, with strategists saying in a note that the “existential tail risk of a euro-zone breakup” has now fallen.

”We have turned cautiously bullish over the last week or so,” said Lee Hardman, a currency strategist at MUFG in London. “Building evidence that the euro-zone economy is through the worst of the Covid-19 crisis and EU Recovery Fund proposals have helped to ease downside risks for the euro, and created a firmer foundation for the rebound to extend from still-undervalued levels.”

In addition to the recovery fund, Germany is preparing a second phase of stimulus of between 50 billion euros ($56 billion) and 100 billion euros, which would help boost sentiment in the euro. And also, measures of manufacturing activity in the euro-area suggest the European nations may be on the road to recovery.

The euro rose 0.3% to $1.1140 Monday, advancing for the fifth straight day in the longest winning streak since March. Its 1.3% advance in May was the biggest monthly gain since December. The end-September forecast in the Bloomberg survey climbed to $1.10 from a low of $1.09 in May.

Option Signal

The option market is mirroring the brightening mood. One-month euro-dollar risk reversals, a gauge of positioning and sentiment, convincingly broke above zero last week for the first time in months, signaling a bullish turn in sentiment toward the common currency.

To be sure, there are still uncertainties weighing on the euro. The European Central Bank's policy decision on Thursday is one, but more importantly, focus is on the June 19 meeting of European leaders to weigh the stimulus proposal, which still needs the go-ahead from the likes of Austria and the Netherlands.

Nevertheless. the view that the worst is behind the euro has gained some ground.

In the “short-term, the euro could test the top of the $1.08-$1.12 trading rage it has been in since last summer,” MUFG's Lee said. “If it can break above, things would get more exciting, otherwise it remains a hard grind higher for now.”