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The 'Hope Risk' for the Euro

After a prolonged slide, the euro is suddenly on a roll. Don't be fooled, this strategist says.

It's been a nice couple of days for euro holders.

When the European Central Bank left interest rates unchanged, and Fed Chairman Ben Bernanke said less gloomy things about the economy than many expected, investors with short euro positions rushed for cover, and raised their hopes that better times in the euro zone are coming.

But don't be fooled, says Jens Nordvig, global head of G10 FX strategy for Nomura Securities. "Hope effects could still see a bounce in EUR/USD to 1.27, given that we are in a technically oversold state," he wrote in a note to clients. (A quick look at traders' short positions show just how oversold the euro is, and Nordvig told me the 1.27 level is "quite likely" at this point.) However, he continues, "it would not be a change in trend. A change in trend is likely to come only from a commitment from fiscal policymakers, which point to a fundamental reduction in uncertainty, about the future of the euro."

Nordvig isn't ruling out a solution to the euro zone crisis. But he argues that until there are significant policy changes, "capital flight, increasing home bias, and accelerating fragmentation are likely to continue. This is the underlying adverse dynamic we are facing."

Nordvig has been a euro seller for a while, often using options. But now, he says, "we are now establishing exposure to a more extreme downside scenario (failure to accomplish integration)."

How low does Nordvig think the euro can go? Here's what he told me: "I think, in the absence of fiscal integration, we trade below 1.20, and 1.10 is very possible within three to four months."

Be careful, euro investors.

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