Central bank policy divergence and actual investment flows suggest that not only will EUR/USD downside continue but the move could actually accelerate.
The fundamentals of policy divergence continue to support calls for EUR/USD downside as ECB will likely embrace QE on Jan 22 while the Fed having ended QE will look to maintain expectations toward liftoff in mid-2015.
But behind this policy divergence also lies actual flows where:
1) investors worried about the implications of Fed tightening to EM are looking for the safety of USD, and
2) eurozone investors are looking for yield pickup beyond domestic markets whereas in the past EUR weakness was related to foreign investors reducing risk.
Expectations have been driving EUR/USD lower but the move will likely accelerate as the ECB delivers QE and especially when the Fed hikes interest rates.
We have suggested that it is attractive to hold 6m 1.15 EUR put/USD call which at time had a theoretical cost of 50 pips. There continues to be value in holding OTM EUR/USD puts given the lack of any signs that the trend is about to turnaround.
We think it is time to think about more accelerated downside and suggest looking at deep OTM puts with the strike at parity.
A 12-month 1.00 EUR put/USD call has a theoretical cost of 45 pips and seems attractive given that policy divergence between the ECB and Fed is likely to widen during 2015.
