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Where the Euro Goes Next

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The "fiscal cliff" negotiations have been rocking the currency markets for some time now, and while a deal of sorts is in place, the buffeting has not stopped.

Case in point: the euro.

The common currency got a big lift on Wednesday as risk appetite rebounded on word that a deal was reached to avert a wave of tax increases and spending cuts. But on Thursday, with investors fretting about what has yet to be accomplished, risk appetite is shrinking again and the euro is sliding.

It may well have more room to fall, according to Steven Englander, global head of G10 FX strategy at Citigroup.

"Our fair value model for EURUSD sent a SELL signal on Dec 31 when EURUSD traded at 1.3193," he wrote in a note to clients. And according to the model, which weighs differences in bond yields, market positioning, and other factors, fair value for the euro has been at 1.2920 for the past several months.

"The model has a good track record detecting turning points in the currency pair," Englander said.

Not convinced? Englander has also compared the euro's current levels to those of other G10 currencies using factors like relative volatility, sovereign debt risks and differences in interest rates, and he found that the euro is overvalued on that scale as well.

It's all starting to sound like justification for a short euro trade. Sure enough, Englander says FX spot rates tend to take about 17 days to converge to fair value.

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