Will We See the Euro Trading Below Par?CME: Micro EUR/USD Futures ( CME_MINI:M6E1! ) #Microfutures
Since the US election last November, the Euro currency has lost ground against the US dollar, with the EUR/USD exchange rate sliding from 1.08 to as low as 1.02.
A combination of new policies from the Trump administration aims to strengthen the dollar. Recent efforts to end the geopolitical crisis will not support the euro. On the contrary, they could push the European common currency below the critical 1-dollar level.
Quick Review of the EUR/USD Price Trend
The euro has swung widely against central bank policies and geopolitical events:
• 2020: The Fed implemented massive stimulus measures in response to the pandemic. Lowering interest rates and increasing money supply reduced the value of the USD
• 2021: The faster vaccine rollout and quicker reopening of the US economy boosted economic growth and investor sentiment towards the USD
• 2022: (1) The Fed raised interest rates to combat inflation, making the USD more attractive to investors compared to the Euro. (2) Europe faced an energy crisis due to its dependence on Russian gas. This crisis led to economic uncertainty and weakened the euro. (3) Ongoing geopolitical tensions created economic instability in Europe, further weakening the euro against the USD
• Q4 2022 and 2023: European Central Bank abandoned its long-held zero-rate policy in September 2022. It raised rates eight times to 4.00%. These actions narrowed the interest rate differentials between the US and Europe, and helped the euro rebound
• 2024: The EUR/USD moved mainly sideways in the range of 1.06 and 1.12. Fed easing and rebounds of US inflation contributed to the mild volatility.
• Q4 2024 to Current. Dollar ascended quickly after the election win of Donald Trump. Investors expect strong dollar with the support of the new America First policies
Ukraine Peace Talks and Possible Outcomes
On February 12th, Presidents Trump and Putin agreed to immediately start negotiations to end the ongoing conflict in Ukraine. On February 18th, US and Russian officials held peace talks in Saudi Arabia. The two sides agreed to create a high-level team to lead the Ukraine peace talks. Neither Ukraine nor the EU participated in the meeting.
How the peace talks would progress remain highly uncertain. Using Game Theory, we could break them down into two mutually exclusive and collectively inclusive outcomes:
• Peace: US, Russia, Ukraine and the EU sign a peace agreement to end the conflict and ensure long-lasting peace. Whether it will be a fair treaty is a hotly debated topic.
• No-Peace: Peace talks break down. The 3-year-long conflict continues. This could last for years but eventually will lead to a win/loss outcome or a draw.
From an investing perspective, “No-Peace” is equivalent to “Risk On”. It may imply higher gold prices, higher energy costs and lower equity value. Meanwhile, “Peace” means “Risk Off”. We may see declining gold, lower oil and gas, and rising stock prices.
However, it would be difficult to pick the price direction if we can’t predict the outcome.
Peace or No Peace – A Steep Cost for Europe
For better or worse, the recent events are a wakeup call to European countries.
The US had defense spending totaling $967 billion in 2024, which is 3.49% of its GDP. For a comparison, the total defense spending for EU member states reached $358 billion in 2024. This represents around 1.9% of the EU's GDP
• The US accounted for 73% of the defense spending in the 32 countries in NATO
• Since 2022, the US contributed to 2/3 of all the financial aids sending to Ukraine
The US administration intends to cut its financial support. Europe will have to increase defense spending dramatically. In a worst case, a complete breakdown in Cross-Atlantic relations could see the US exiting NATO and all US troops withdrawing from Europe.
How much is the spending gap? In 2024, Russia had defense budget of $462 billion, or 6.7% of its GDP. Ukraine had defense budget of $40 billion, or 22% of its GDP.
• EU plus Ukraine spent $64 billion less than Russia in defense budget.
In my opinion, in a Peace scenario and with reduced US involvement, the EU defense budget must surpass that of Russia to ensure Ukraine to stay on top. I find this to be 2.5% of GDP. This means a 32% increase or $471 billion in total defense spending.
For No-Peace, the EU will be fighting an active war. NATO will need to maintain a standing army of 1 million troops and rebuild an entire defense industry. In this scenario, I feel that the defense budget needs to double 5% of GDP. budget to raise a large army and rebuild an entire defense industry. This means a 163% increase or $942 billion in total defense spending.
If the above numbers sound outrageous, Israel, a country constantly fighting for its survival, will serve as a good refence point. In 2024, Israel's defense spending amounted to 117.5 billion Israeli shekels (around $32.5 billion USD), which is 6.7% of its GDP.
The EU has an estimated GDP growth at 0.9% in 2024 and a forecast growth of 1.5% in 2025. The defense budget increase will cause mandatory cuts in non-defense spending. The combined effect will be negative, pushing GDP growth into a negative territory.
In my opinion, re-arming Europe is critical to its survival. However, defense buildup comes at a steep cost. The expectations of lower GDP growth will push the value of Euro currency lower, likely below the 1-dollar critical level.
Commitment of Traders shows diminishing bullish sentiment
The CFTC Commitments of Traders report shows that on February 11th, total Open Interest (OI) for CME Euro FX Futures is 622,873 contracts. “Asset Manager” (i.e., hedge funds) own 338,182 in Long, 177,937 in Short and 35,597 in Spreading.
• While they maintain a long-short ratio of 1.9:1, hedge funds have reduced long positions by 1,014 while increasing short positions by 2,249.
• This indicates that “Smart Money” is becoming less bullish on the Euro.
Trade Setup with Micro Euro/USD Futures
If a trader shares a similar view, he could express his opinion by shorting the CME Micro Euro/USD Futures ($M6E).
M6E contracts have a notional value of 12,500 euro. With February 19th settlement price of 1.0435, each March contract (M6EH5) has a notional value of $13,044. Buying or selling one contract requires an initial margin of $260.
Hypothetically, a trader shorts March M6E contract and the euro drops to $0.99. A short futures position would gain $668.75 (= (1.0435 – 0.99) x $12500). Using the initial margin as a cost base, a theoretical return would be +257% (= 668.75 / 260).
The risk of shorting euro futures is rising euro. Investors could lose part of or all their initial margin. A trader could set a stop loss while establishing his short position. In the above example, the trader could set a stop-loss at 1.06 when entering the short order at 1.0435. If euro rebounds, the maximum loss would be $206.25 ( = (1.06 – 1.0435) *12500).
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Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
