Currency investors should consider selling EUR/USD this week, advises Morgan Stanley in its weekly FX pick to clients. With a relatively light data week from the US side, the market will be looking for signs from the rest of the world for the direction of the USD. We still expect the USD to appreciate, with the market appearing to underprice the Fed for this year. That said, we understand that the USD is at a crossroads, with political related risks being a major driver. We think there is good risk reward in buying the USD vs the EUR this week.
The FX market doesn’t appear to be pricing in any worries about peripheral spread widening which we think would weaken the EUR if it results in a reiteration of the accommodative monetary stance from the ECB. We are now focusing on data from Italy over Germany because the ECB’s stance on inflation will likely be needed to cater for EMU’s weakest link.
We looked at the Euro Area in detail. We suggested that EMU is far from being a homogenous enough area to allow the ECB to run optimal monetary conditions. What may be too loose for the core may be too tight for the periphery, opening scope for policy mistakes and subsequent volatility. At this stage, investors should not read better core data as a EUR-positive, in our view.For EUR to rally it would require the periphery to show better data too, which has not happened compared with the booming German economy. Simultaneously, EMU spreads have started to widen while EMU’s TARGET2 balance sheet approaches levels last seen in summer 2012, just before ECB President Draghi suggested that the ECB would do “whatever its takes” to preserve EUR.
A risk for this trade comes from the USD side, with political commentary having the potential to hurt sentiment,