Euro: Positioning turns net short – BNY

Geoff Yu notes that custody clients tracked by BNY Mellon’s iFlow have shifted back to net short Euro, with hedging activity driving a rotation out of the Eurozone into Switzerland, Nordic economies and the U.K. He stresses that EUR/USD is not yet aggressively underheld, leaving room for further selling and making a durable bottom in the currency unlikely until tightening is priced out of the curve.

Custody flows point to more downside

"iFlow shows custody clients are back to net short in euros. This was the default position for much of Q2 as markets scrambled for dollars, but the latest move is more euro-specific, driven by increased hedging among cross-border clients."

"The euro still isn’t aggressively underheld. The sharp swing in EUR holdings – from around 50% overheld relative to the rolling 1y average to slightly underheld – is striking, but in absolute terms current EUR shorts aren’t excessive."

"Unlike overall EUR holdings, EUR/USD holdings aren’t weak relative to recent history, suggesting more of the EUR hedging is taking place on the crosses. iFlow points to some rotation out of the Eurozone into Switzerland and the Nordic economies, where fiscal strength is unimpeachable, while the U.K. has also been a beneficiary."

"Weaker euro eases pressure to tighten elsewhere in Europe. As a byproduct, this rotation has pushed up effective exchange rates across the rest of Europe and, at the margin, reduced the need for tightening there."

"Current EUR holdings and valuations are a long way from 2024 levels, leaving room for further selling. We’re reluctant to call a bottom in the currency until tightening is priced out of the curve."