A look at how the market is pricing EURUSD

Ahead of the outcome of the Eurogroup meeting this weekend, we thought we'd take a look at the EURUSD from a number of different angles to see where things stand and hopefully provide some perspective ahead of Monday’s open.

Remember the post-kneejerk implications if EU officialdom/the ECB manage to pull together and salvage the the critically wounded EU ship because any viable solution has to involve de facto large scale QE. So at what point would a relief rally based on eased pressured on sovereign debt/banking system transition to mulling the competitive devaluation angle of yet another currency joining the "QE crowd"? For now, it appears the market either wants to party, or that the risk/Euro shorts are running for the hills.

Chart: EURUSD vs. CB Expectations
Here we use the two year swap spread to represent CB expectations, as 2-years out is about the maximum influence traditional monetary policy can have. With the US rate expectations essentially at nil for the next two years because of recent FOMC promises to keep the rates low until mid-2013, this is effectively all about the signals from the ECB and whether it unwinds its (vigilant?) two rate hikes from this year and then some going forward. It also becomes a question of “relative QE” – and in that instance, would be interesting to see if an Operation Twist from the Fed is supportive for the USD if it raises rates at the front end of the curve while the world recognizes an EU “solution” for the effective massive QE that would be required to implement it. By a pure rates measure and from past history, EURUSD looks like “fair value” at around 1.35 or a bit lower. Data source: Bloomberg.



Chart: EURUSD vs. Basis swaps
This is the measure that shows the degree of the USD funding strain on EU banks – note how yesterday’s coordinated intervention move has helped encourage the recent bounce in this measure. Data source: Bloomberg.



Chart: EURUSD vs. Germany/US CDS spread
This is a simple spread on the CDS spreads of Germany vs. the US. Interesting that the spread hasn’t improved much in Germany’s favor as EURUSD has bounced. (NOTE: price data only updated through yesterday’ close on the CDS prices).  Data source: Bloomberg.