Euro Jumps as Hedgers Let go

A weak US GDP report crushed the dollar but the Fed continues to look toward a brighter future. The dollar was near the bottom of the FX rankings but bounced on the Fed to finish ahead of JPY and NZD. The kiwi was hurt by the RBNZ and the yen is in focus with the BOJ later. Yesterday's EURUSD trade came close to its final target and remains in the green. EURAUD deepens, while NZDUSD,  GBPAUD, and EURGBP premium trades remain in progress. AUDNZD long was opened minutes prior to the RBNZ announcement and remaisn  well in the green.

At this point, most of what can be said about Q1 GDP (dismal) and the Fed (optimistic) has already been said. Instead, we take a look at the intermarket dynamics that illustrate the squeeze that's taking place in the euro, which posted its best day in six months. Knowing whether it's a squeeze or a fundamental trade helps us decide what to do next.

Looking only at FX, we know that euro shorts are a crowded trade. The CFTC futures positioning data shows net shorts near a record. That alone left EUR/USD shorts vulnerable to a squeeze but earlier this year they held strong in tests of 1.10.

How do we know this time was different?

We know because the euro trade wasn't only in FX. Many traders focus only on the market in front of them but taking a broader view shows us that long-term trades are clearly being unwound. One major trade has been the ECB QE bond trade with many funds outside the Eurozone taking part. They bought German Bunds, helping to drive yields below 0.10% but a large portion of those traders hedged the FX portion of the trade because, naturally, they were worried about euro weakness.

In the bond market today, there was clearly a rush to the exits in German Bunds. Yields moved up 12 basis points to 0.285%. As those traders exited the trade, they also unwound those hedges, which meant buying euros and selling dollars.

The same trade took place in the German DAX. The main stock index was down 3.2%.

In summary, today's trade had all the hallmarks of institutional, real money traders bailing out on what had been a very successful trade. That kind of thing can feed on itself for days. Keep a very close eye on Bunds and the DAX in the days ahead for clues about whether strong hands step back in or if more cash out.

In the near term, the focus moves to the BOJ. Expectations of any action should have fallen to nil after a report today in Nikkei that Kuroda is set to maintain a forecast for a gradual rise in inflation. Question about more action has moved toward October.