The euro has plunged 15 percent against the dollar over the past three months, a monster move for a major currency. And more volatility is likely ahead, as the Federal Reserve is set to release its highly anticipated policy statement on Wednesday.
All eyes are on one word: "patient." If the U.S. central bank does what many investors now expect, and ceases to say that it will be patient in normalizing policy, the Fed could then raise rates as early as June. A rise in short-term rates is good for the dollar and bad for the euro, as it makes holding dollars a more attractive proposition.
But Neil Azous, managing member of advisory company Rareview Macro, is more focused on what will happen if the word stays—particularly because the short euro trade has become so popular on Wall Street.
"The majority of new short positions in the euro-dollar are clustered between 1.06 and 1.08. Therefore, the location that one shorted is very poor if the FOMC leaves the word 'patient' in their statement, as the market will interpret that as a dovish signal. While that will not derail the medium-term trend on the euro leg due to 'QECB' [that is, the European Central Bank's quantitative easing program], there is short-term risk of a euro cover," Azous wrote to CNBC.
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And with so many betting against the euro, the mere risk of this outcome could lead to a sharp counter-trend rebound ahead of the meeting.
"It is going to be a long and possibly unpleasant night if you are short of the euro," Azous predicted.
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"On a short-term basis, we could have the strong chance of a pop in the euro, just because the sentiment is so incredibly skewed against the currency," agreed Boris Schlossberg, managing director of FX strategy at BK Asset Management.
"Anything [Fed chair Janet] Yellen says that could support the dollar could lead to a short-term short-covering rally on the euro. I think we see 1.07 before we see parity," Schlossberg added, referring to the much-awaited condition in which each euro costs just one dollar.
