The euro has rallied about 1% and has spurred talk of ECB intervention. We are skeptical. There seems to be little reason to expect the ECB to intervene outside of its time zone in a unilateral fashion. Convention, we understand, would dictate that the ECB would have to notify (ask permission?) of the Federal Reserve to intervene in the US market. In addition, the ECB would intervene to drive a message home to the market and to burn the fingers if not more of the speculators. It would seek to get the biggest bang possible, in which case there would be no doubt whether there was intervention of not. A more likely explanation is that the Swiss National Bank or one of its agents became more aggressive or shifted tactics. The move seemed to have been led by the euro-franc cross and dollar-franc.
The market is on edge. The implied volatility, the premium for euro puts over euro calls, the large positions that have been built up all point to a vulnerable market–vulnerable to a short squeeze. There have been veiled threats of stronger action. This will not change sentiment very long. In fact, what happened earlier this week was that as the euro stabilized, the demand for euro puts increased as if the speculative positions were being rolled out of spot and into options. With the European debt crisis posing systemic risk and threatening to undermine the fragile economic recovery, European officials are coming under increasing pressure to act decisively. What is driving the price action now is not value but risk management. Stop losses are being triggered on the euro against the dollar and on the crosses as well. The extreme positioning warns of potential sharp price action. At the same time, these little episodes, like earlier this week, will lose their ability to impact prices in terms of duration and magnitude.
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