Trading EUR/USD Downside: Drivers & Targets - Nomura

It took fairly severe risk aversion to see a squeeze in EURUSD up to above 1.25 earlier this week; and now that markets are relaxing (and the Fed helping) we are quickly back to the lows, notes Nomura

"The correlation between risk assets and the Euro is linked to the structure of capital flows. When risk appetite is there, there is steady capital outflows from the Eurozone. When there is risk aversion, there can be temporary repatriation, and the Euro benefits. The key to the Euro outlook in 2015 is the degree to which Eurozone investors will push capital abroad," Nomura argues.

EUR downside: drivers.

In particular, Nomura thinks that the bearish EUR trend has potential to accelerate into 2015, for five reasons.

First, real rates on an absolute and relative basis are declining in the Eurozone.

Second, nominal rates are negative for a pool of fixed income instruments of around EUR900bn held by Eurozone investors. This is an incentive to shift abroad.

Third, as Spanish and Italian yields decline further, the home-bias in the periphery can decline from very elevated levels.

Fourth, ECB QE, will remove hundreds of billion worth of Eurozone fixed income assets from the market, spurring investors into substitution into foreign assets.

Fifth, ECB QE and the liquidity creation associated with it may improve risk sentiment and ignite portfolio outflows through a sentiment channel.

EUR downside: targets.

"We think 1.20 will be reached by January, and we can see 1.15 by Q2 2015...The levels, for shorts, may be worse in early January when most investors will be re-engagin," Nomura projects.