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What’s behind Euro’s sharp rebound?

The biggest banks are unwinding their short positions against Euro.  Whenever a large number of negative bets on a currency is closed, that currency climbs.

Story from WSJ:

Some of the world’s most prestigious foreign-exchange banks are ripping up their gloomy forecasts for the rallying euro.Several of the top banks in the business are backtracking on their previously dire predictions for the single currency, most of which were formed when the European monetary union itself seemed in peril during April and May this year.

Some believe this is nothing new, a natural consequence of the market’s stabilization after an extraordinary run of events for major currencies this year. However, some industry veterans say that the market is now beholden to new forces that few if any market watchers yet fully understand.

…On Monday, Switzerland’s UBS AG —the world’s second-biggest bank in foreign exchange—tore up its forecast for the euro to be trading at $1.20 against the dollar in the next month. It now expects to see the currency at around $1.28—a 6% revision.

In a separate research note, the bank described the euro as “exasperating,” adding that the currency’s rally from under $1.19 in early June to over $1.30 by late July had “wrong-footed many in the currency market.”

Other banks caught off guard include Credit Suisse, another top-10 operation, which in late July upgraded its three-month forecast for the euro’s level against the dollar to $1.30 from $1.16, citing, in part, “a more rapid than anticipated recovery in euro-area policy credibility.”

BNP Paribas SA, whose analysts have held some of the gloomiest views of any in the market, took a similar step towards the end of July. “We still expect the euro to trade lower against the dollar, but the trough should be near $1.10 rather than $0.97,” the bank said.

European regulators’ stress tests on the region’s banks have played a big role. The generally upbeat results were roundly criticized when they were released July 23, but longer-term, the tests have rebuilt confidence in Europe’s financial sector and eased nerves over the euro area’s government bonds.

In addition, concerns that the U.S. may slip back into recession, and that the U.S. Federal Reserve may be drawn into further bond purchases to support the economy, took many in the market by surprise, and hit the dollar hard.

“We don’t often get extremes of pessimism like we had in April and May. It was dangerous,” said Marshall Gittler, a director and chief strategist at Deutsche Bank Suisse SA in Geneva, who has been watching the currencies market since 1998.

“We have gone from an Armageddon scenario, where some people thought the euro really might break up, to euphoria, or at least a return to normality, in a very short time,” he said.

Mr. Brown at Mitsubishi said that the sorts of hefty revisions banks are making now are a common part of the market’s rhythm. “My broad view is that it’s no harder to predict currency movements than it ever was,” he said.

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