Deutsche Bank: 2 Reasons Why Short EUR/USD Targeting 1.20 Is One Of Our Top Trades

Deutsche Bank has turned bearish EUR/USD at the beginning of March. Today, DB reiterates this bias seeing the short EUR/USD trade targeting 1.20 as one of its top trades for this year.

Beyond its broad bullish dollar view, DB sees two factors driving the pair towards the 1.20 target:

First, DB sees divergence in conventional policy expectations (rates) returning.

"For all the unconventional measures since 2008, the remarkably consistent pricing of 2-year ahead rates paths from the Fed and ECB post Lehman is what stands out. We think this year will mark the beginning of renewed divergence. On the Fed side, mid-2015 guidance is soon coming into view for 2-yr rates making the entire US yield curve "live". In contrast, the ECB is re-opening a discussion around negative rates and strengthening its verbal guidance on "low for long" via multi-year liquidity commitments," DB clarifies.

Second, and more importantly, DB sees the reduction of Eurozone risk premia as negative, not positive for the EUR. On the one hand, its models suggest there is little redenomination risk priced into the EUR anymore.

"This has seen the correlation with Euro peripheral bond spreads and EUR/USD drop to close to zero, and makes the potential (negative) EUR/USD reaction to a return of tail risk very asymmetric. Most importantly, the big story over the last five years has not been a lack of inflows into the Euro-area, which have remained remarkably steady. It has been domestic risk aversion. This has seen large waves of repatriation and the building of more than EUR 1trillion worth of under-weights in foreign assets. Lower tail risks and a gradually improving business cycle should see a return of these outflows,' DB adds

"So we think EUR/USD is fully capable of participating in a USD rally, even if it lags the move lower in many other crosses," DB concludes.

Copyright © 2013 eFXnews