Currency Contest

Euro Strength Misleading, More Artificial Than Authentic

Joel Kruger,

With all of the negative attention in the Eurozone, it is somewhat surprising to see the Euro holding up as well as it has over the past few weeks. In our opinion, this is a currency that should be trading a good deal lower and we continue to project additional declines into the lower 1.2000’s over the coming weeks. At the moment, Eurozone peripheral bond spreads continue to widen to alarmingly high record levels, and with Italian yields next targeting the 8% mark and Spanish yields now on the verge of crossing over the 7% threshold, we do not see any light at the end of the tunnel. While Eurozone officials have been doing what they can to address the crisis, investors should be reminded that this is a big mess that involves the consent of a number of countries under one unified union before anything can ever get done.

Of course, some countries are better off than others, and there is a sentiment within these stronger countries that they should not be burdened with the heavy responsibility of rescuing the other less fortunate countries. While on the surface, there exists a mask of diplomacy and desire to find a unified solution, the disjointed nature of the situation, clearly makes this an extremely challenging crisis to overcome. Recently, Dr. Doom, Nuriel Roubini was on the wires saying that it would only be a matter of time before a Greek exit, and to make matters worse, Germany’s Merkel is still adamantly opposed to the idea of the European Central Bank becoming the lender of last resort to bail out the beleaguered, debt ridden peripheral nations. This only adds to the incredible pressure on the region, with a very limited amount of funds currently available in the EFSF. Merkel will be meeting with UK Prime Minister Cameron today, and we would expect to see some tension at the meeting with the two countries holding different views on the crisis.

On the shorter-term time horizon, if the market can establish above 1.3560 on Friday, there are risks for a bit of a bounce, potentially back into the 1.3700 area. But we would be aggressively selling these rallies, as any move higher in the Euro will likely be driven by some form of official central bank or coordinated government action to help temper investor fear and stimulate the local economy. But at the end of the day, should this action then really be taken as a positive risk development and one that warrants legitimate investment in the Euro? We think not, as it only reaffirms the severity of the overall situation.

Technically, we continue to defer to the EUR/USD monthly chart, which has been extremely useful this year. The market looks like it has been in a steady downtrend since positing record highs in 2008, and is now in the process of a carving out the next major lower top below 1.5000 ahead of a retest of some multi-month range lows in the lower 1.2000’s. Once the lower 1.2000’s are tested, it is entirely possible that we see further acceleration towards parity, but at this point, it is way too premature to make such calls and we will have to step back an reassess when the market gets down to our lower 1.2000 area objective.