“I wonder whether we’re not living in a new world in which governments no longer control as much as they think they control,” Mohamed El-Erian, Allianz chief economic advisor, told the crowd of hedge fund gurus at the annual SALT conference on Wednesday.
Maybe he’s on to something.
Acting under pressure from many Eurozone governments that believe it will save their hides, and acting out of its central-bank logic, the ECB is trying bash down the euro. For years, it threatened to print money. Now it is actually printing money and buying debt, and it’s inflicting its negative deposit rates on the markets. This drove much of European sovereign debt into the absurdity of “negative” yields – in quotation marks because logically, there should never be such a thing. But in this upside down era of central-bank deities, everything is possible.
At the same time, the Fed stopped QE and is currently contemplating interest rate increases. This juxtaposition of euro easing and dollar tightening unleashed a ferocious tsunami of hot money from Europe to the US.
As a result, the euro plunged 25% against the dollar within 12 months, from $1.40 to $1.05 by mid-March. For shorts, it was the biggest no-brainer in the history of mankind. Everyone was short the euro. They were doing what the ECB wanted them to, which was push down the euro. Central banks and governments alike felt in control.
While the dollar was on its precarious perch, DoubleLine Capital’s bond guru Jeffrey Gundlach said on March 10: “The dollar has been a world beater, and will continue to be a world beater until it becomes economically too painful, and maybe that’s what the stock market doesn’t like.” It would be a bold contrarian move to short the dollar, he said, “but I say ‘don’t do it’, because sometimes the consensus is right.”
But the consensus was wrong. And we suggested as much [The World’s Most Popular Trade May Soon Explode]. After its dip below $1.05 on March 15, the euro began its phenomenal ascent against the dollar.
Late Wednesday, the euro hit $1.14 and for the first time in a year broke through its 100-day moving average. The past 10 sessions amounted to the most potent 10-session euro rally since September 2010. Big currencies don’t often move like this.
“While this may not make sense given that Europe is printing money, it’s important to notice that many investors are short the euro,” wrote Christine Hughes, Chief Investment Strategist at OtterWood Capital.
The chart shows the drubbing the euro took in the second half of 2014 and the first few months of 2015, followed by this rally – which seems still tiny, compared to how far the euro had dropped.
The lower section of the chart shows the record net short positions that helped beat down the euro. Not even during the worst chaos of the euro debt crisis from mid-2011 through 2012 was the fat bulge of net-short positions this massive. And now, the shorts are getting squeezed like an overripe lemon.
“Whenever a consensus is so unanimous, our gut tells us it is wrong,” BlackRock, largest asset manager in the world, had warned about the dollar in its 2015 Investment Outlook. “Stretched positioning means even a mild disappointment to dollar bulls could prompt a sell-off in the currency.” I wrote about that envisioned dollar “air pocket” at the end of December in the middle of the dollar rally, when shorting the euro was all the rage, and caught some heat over it.
The euro’s rise for now is a short-squeeze, nothing more. Nothing goes to heck in a straight line. And long term, the euro is in a race with the dollar and other currencies to get there first.
But the euro’s “unexpected” rise is very bad news for the ECB that pretended that it was in total control. It comes just as oil prices have jumped and as Eurozone government bonds are in a rout.
European governments have been counting on the US shale revolution to keep oil cheap. They’ve been counting on the ECB to keep its promise and fight that currency war for them, and knock down the euro. And they’ve been counting on the ECB to force markets into providing nearly free debt. That’s how there were going to fix their bogged-down economies.
This new environment of a euro gone haywire in the hands of an epic short squeeze and of government bonds feeling the pull of gravity doesn’t bode well for the ECB’s god-like aura. It might expose its policies as a failure even among those who otherwise are proponents of QE and interest rate repression. And that’s where El-Erian had nailed it: these all-controlling entities might “no longer control as much as they think they control.”
What’s going on in the bond markets is a doozie. “The short of a lifetime,” Bill Gross called it. Bonds with long maturities have become sitting ducks – and thus ideal. Read… “Smart Money” Prepares to Profit from Bond Market Rout
Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate “beer money.” I appreciate it immensely. Click on the beer mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.