Just days before US President Donald Trump threatened new tariffs on European nations over the Greenland issue, hedge funds had already astutely exited their bullish bets on the euro. This timely adjustment in positioning revealed that some market capital had sought safe havens in advance of this escalating geopolitical tension.
Data from the US Commodity Futures Trading Commission (CFTC) showed that leveraged funds' positions on the euro had shifted to a small net short in the week ending January 13. This marked the first bearish turn in capital flows since late November last year. This shift occurred before the tariff threat became public and could potentially intensify the downward pressure on the euro.
On the news front, President Trump announced via social media that he would impose an additional 10% tariff on eight European countries that opposed his acquisition of Greenland, with the rate increasing to 25% after several months, until an agreement on the "complete and total purchase of Greenland" is reached. This has sparked market concerns about a potential trade war.
Concerns about a reignited trade war are heating up, prompting investors to begin assessing the potential damage this could inflict on European economic growth. Affected by this uncertainty, the euro initially fell then rose after the news broke, declining 0.2% before rebounding 0.4% to $1.1641, while the Bloomberg Dollar Spot Index fell 0.2%.
Morgan Stanley had previously warned that traders are currently underestimating the risk of extreme scenarios, which could trigger significant volatility in major currencies, particularly the euro.
The capital shift aligns with deteriorating technicals, and geopolitics presents a double-edged sword effect. CFTC data reveals a notable reversal in market sentiment. The fact that leveraged funds flipped from long to short at a critical juncture indicates that some institutional investors were already hedging against potential policy risks. Nick Twidale, Chief Analyst at AT Global Markets, pointed out that hedge funds would be comfortable with the current net short position, and might even seek to increase their short exposure if this "dispute" appears likely to escalate into a full-blown trade war.
Simultaneously, technical indicators are beginning to align with the bearish shift in positioning. The euro's long-term momentum signal turned negative last week for the first time in nearly a year, ending a previous 43-week bullish streak. Historical analysis shows that while such a signal reversal does not guarantee a sell-off, it often precedes significant declines when the signal persists, suggesting the euro faces asymmetric downside risks.
Regarding future trends, market views express cautious pessimism. Strategists Joseph Capurso and Carol Kong from the Commonwealth Bank of Australia wrote in a report that, affected by the tensions, the euro might test the support level of 1.1499 against the US dollar this week. They believe the trade dispute centered on control of Greenland is likely to escalate before it cools down. Bloomberg Market Strategist Conor Cooper also noted that the euro's modest decline might indicate that traders are simultaneously wary of the negative impact on the US dollar.
Despite the prevailing bearish market sentiment, the spillover effects of geopolitics could be a double-edged sword. If the situation evolves into a broader issue concerning the US dollar, the euro might find some support. According to an analysis by a Deutsche Bank strategist, President Trump's trade threats to European governments over Greenland increase the possibility that the latter might reduce their holdings of US assets, which would be beneficial for the euro. The potential for capital repatriation could limit the euro's downside, although data from the options market shows traders' confidence in the euro's upside appeal is waning.
