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June 19th 2010

Euro Rally only Temporary

Something incredible has happened: The Euro has reversed is 16.5% decline (from peak to trough), and since bottoming on June 7 at $1.1876, it has risen by an impressive 4%. I guess that means the Euro has been rescued from parity (which I characterized as “inevitable” on June 5)?

EUR USD 3 Month Chart
Not exactly. While financial journalists have interpreted this as a recovery in risk appetite, and mainstream investors dismiss all of it as mundane fluctuations in exchange rates, currency traders – both fundamental and technical – know better. They know that this rally is merely a correction, the product of the Euro falling too much too fast against the Dollar and a consequent short-squeeze. They know that there is nothing underpinning the Euro rally, and that since the bad news continues to emanate from the Eurozone, a further decline is inevitable. ” ‘We could be one or two headlines away from a crisis again. This problem didn’t occur in a couple of days, nor is it going to resolve itself in a couple of days,’ ” summarized one trader.

According to Brown Brothers Harriman, ” ‘The recent euro rally is a corrective phase in a bear market and not a change in trend.’ National Bank Financial added, ” ‘Ultimately, when the market is this short a particular currency and a pullback happens, it results in some price volatility. It doesn’t necessarily reverse the longer-term trend.’ ” Given that so-called net-short bets against the Euro rose to a near record high in the beginning of June, it was inevitable [to borrow my favor word of the moment] that traders would eventually “cut positions when momentum in a currency [the Euro] shifted.”

From a fundamental standpoint, the last two weeks have brought further indications that the crisis is still mounting. The credit rating on Greek sovereign debt was cut to junk (A3) by Moody’s, following a similar move by S&P in the spring. Fitch, while arguing that the Euro has already declined “too far” is simultaneously threatening to do the same.

Meanwhile, Spain managed a successful debt auction, but at interest rates nearly 1.5x what it had to pay the last time around. Still, it’s in a more favorable position than Greece, which is now paying a yield premium of more than 600 basis points on its debt, compared to Germany. The implications for currency markets are clear enough: “There is a little bit of a disjuncture between what the currency is doing and what these bond markets are doing, and that’s a problem for the euro.”

Politicians, for their part, are still struggling to convince investors that they are serious about trimming their budgets and uniting for the sake of the Euro. “I see good news from the current euro-dollar rate, French Prime Minister Francois Fillon told reporters…’and I have been saying for years that the euro-dollar rate didn’t reflect reality and was penalizing our exports.’ ” With comments like that, is there any cause for believing them?!

Even putting politics and economics aside, there is a force that will continue to punish the Euro regardless of what happens: the carry trade. According to the WSJ, there is “some evidence that investors are indeed using euros to finance their bets. That is important because it means there may be structural reasons in the investment world why any lift in the euro will simply be quashed.” Thanks to the promise of continued low interest rates and confidence in its decline, ” ‘The euro is the clear-cut funding currency of choice.’ ”

At this point, then, the only issue is when the Euro will resume its decline. Those with a technical bend think that the Euro will fail to breach a psychologically important level (perhaps $1.25 or $1.27) after exhausting the rest of its momentum, at which point it will resume its precipitous decline. Those who see things in fundamental terms argue that when this happens, it will likely be due to more bad news about the crisis and/or a recovery in risk appetite (the contradiction between the two notwithstanding).

Rest assured, Euro bears. Your friend, the trend, is still intact.

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Posted by Adam Kritzer | in Euro, News | 4 Comments »

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4 Comments of “Euro Rally only Temporary”

  1. Ted Wood Says:

    Everything is temporary

  2. Keiran Says:

    I think this rally is going to surprise you all with 1.30 at least in sight. The fundamental driver is the E.C.B’s trillion dollar commitment to the Eurozone members and its currency

  3. Clement Says:

    I agree with you.I purely base my trades on technicals,although i use fundamentals which once in a while either lags or help to put pressure on the trend.I believe strongly that decline of the pair should be at 1.2500-1.2600 area and then down targetting 1.2200-1.2000 area.

  4. K Mehrer Says:

    Adam
    I wanted to ask your advice on how to get started with FOREX trading, I am thinking I would like to take a look at EUR/USD first til I get the hang of it.

    I have only traded stocks in the pharm and gold sectors and done pretty well, but I would like to take a short term look as well, especially with the plethora of economic issues, I am thinking that there is a good chance to at least re-feather our nest.

    Any suggestions would be appreciated…remember, I am new and am trying to learn the lingo etc.

    Thanks!
    K Mehrer

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