May 14, 2015 / 1:11 PM / 2 years ago

Sell euros? This year's dead cert becomes frustrating trade

* Euro up 9 pct from 12-year lows vs dollar

* Rising German bund yields have underpinned euro

* Forecasts for euro/dollar parity being challenged

By Anirban Nag

LONDON, May 14 (Reuters) - Revised expectations of when the Federal Reserve will raise interest rates and a sell-off in German bonds have catapulted the euro from 12-year lows, frustrating all those who bet the single currency was heading for parity against the dollar.

In the derivatives market, currency options show the bias for further euro weakness is waning fast , and some macro funds are closing bets against the euro.

It may be too early to call a decisive turn by the euro, which fell from $1.3910 in May 2014 to a 12-year low of $1.0457 in mid-March. But a few banks are recommending clients take advantage of its recent bounce and buy euros.

That contrasts with a wave of "sell" recommendations at the start of the year. Forecasters predicted then the European Central Bank's 1 trillion-euro bond-buying programme -- quantitative easing -- would drive the euro below $1.00 within months.

Speculative bets against the euro peaked in late April. And then the tide turned.

"All those expecting the euro to drop to parity and below will have to step back and re-assess," said Jeremy Stretch, head of currency strategy at CIBC World Markets. "There is a growing frustration in the short euro/long dollar trade."

Most banks have not publicly changed their bearish euro forecasts. But since its mid-March low, the euro has gained 9.3 percent to trade above $1.14, and on a broader trade-weighted basis, it has risen 3.3 percent in the past month.

One reason for the euro's recovery has been a steady stream of improved euro zone data. In contrast, growth in the first quarter in the United States was disappointing. That has prompted many to push expectations of the first Fed rate hike to the end of the year, from June earlier.

A narrowing yield gap between German Bunds and U.S. Treasuries during the global bond rout that took hold in late April has also supported the euro.

With German sovereign yields rising at a faster pace, the gap between 10-year Bunds and Treasuries has shrunk to 152 basis points from 182 a month ago. That makes the euro more attractive to investors chasing higher yields.

In mid-April, with most euro-denominated bonds trading in negative territory, many were expecting the 10-year Bund yield to drop below zero, having hit record lows of 0.05 percent.

CLOSING SHORT BETS

Mark Haefele, global chief investment Officer at UBS Wealth Management, said the rise in euro-denominated yields would lessen the potential for outflows from fixed-income assets in the months ahead.

"We have decided to close our underweight position in the euro relative to the dollar," he said. "The trade's risks now outweigh the likely rewards."

For many funds, asset managers and speculators, short euro/long dollar was one of the hottest trades to take advantage of the diverging monetary policy outlooks between the Fed and the ECB. That made it a very crowded and one-sided bet.

Data from the Commodity Futures Trading Commission showed speculators have been cutting record-high short euro positions, giving a fillip to the single currency.

In March, HSBC went against the tide and raised its forecast for the euro to $1.20 by year end. Now analysts at Westpac have joined in, recommending buying the euro, which they say could run up to $1.15.

"All our model signals are bullish euro - higher bund yields drag up our euro total yield signal, better data trends of late give the region a positive growth signal ... while the region's still very healthy external surpluses keep our current account momentum model firmly bullish euro too," Westpac said in a note.

Reporting by Anirban Nag

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