Forex Flash: Cautiousness returns to EUR – UBS

According to Research Analyst Gareth Berry at UBS, “Our most recent edition of FX Flow Monitor indicated some caution returning to the euro on the part of asset managers and hedge funds. Elections in Cyprus and Italy may have played a role, however the perceived escalation in currency war rhetoric likely played a more dominant role.”

In particular, there was the prospect of the ECB beginning to actually make an attempt to 'not lose' the currency war, or at least not come out the worst off. ECB President Draghi chose not to stoke any flames during his Parliamentary Testimony on Tuesday. However, given the euro at this point has the most to 'lose' by gaining strength, there should be a commensurate rise in the currency's risk premium, especially in the options market.

With policymakers and lawmakers in the Eurozone (with France perhaps being the exception) choosing to give the ECB full authority over policy, this should include the capacity to execute rhetoric as well. Nonetheless, if the ECB's Governing Council should choose, there is a separate way to influence FX more indirectly, which would be by guiding liquidity expectations within the Eurosystem and managing changes in the size of the ECB's own balance sheet. The best example would be to stop overtly praising massive LTRO repayments, especially if the true strength of the region's banking sector remains under scrutiny.