Ultimate Contrarian Trade: Buy Euro

Contrarian traders are contemplating going long the euro, which has been the market’s punching bag for the last month and one of the most successful shorts for hedged funds since housing.

“The euro is failing to rally on good news — whether of an economic or a political nature,” wrote Audrey Childe-Freeman, senior currency strategist for Brown Brothers Harriman, in a note to clients. “In this context, it is rather controversial to be anything but a euro bear, but this may be the time to identify a few constructive developments and to get prepared for a potential correction” to the upside.

The currency is up a second day versus the dollar after Federal Reserve Chairman Ben Bernanke told a Congressional panel that the US would do what it can to support the European debt crisis. Bernanke has already opened up emergency swap lines as a backstop for the Europe’s crisis. The European Central Bank meets tomorrow.

The euro fell to a four-year low on Monday as hedge funds ganged up on the currency in a bet that any rescue package for Greece will only temporarily delay the spread of the crisis to other countries such as Hungary and Spain. Just a quarter of hedge fund managers believe any rescue package will have a positive long-run impact, according to a survey of investors by TrimTabs/BarclayHedge. About half of the managers are bullish the dollar.

“The bailout received a cool greeting, even within the euro zone,” said Vincent Deluard, global equity strategist at TrimTabs, in the survey release yesterday. “The ‘shock and awe’ rescue package is unlikely to prevent speculators from attacking European currencies and punishing heavy debtors.”

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In her note, Brown Brothers Harriman’s Childe-Freeman laid out seven reasons be “constructive” the euro in the face of all this pessimism, including that the short trade may be too overcrowded, the euro zone is now actually a step ahead of the US in addressing ballooning deficits and renewed cooperation between the French and German governments. She also played down rumors that central banks, including China and Japan, would be selling their euros.

The CurrencyShares Euro Trust, an ETF which attempts to mimic the movements of the currency, pared its 2010 decline to 16 percent following Bernanke’s remarks.

“Bernanke will defend the euro to stave off panic in our markets,” said Joe Terranova, chief market strategist for Virtus Investment Partners and a Fast Money trader. “He’s doing it through words now, but deep down he hopes it never leads to action.”

Traders are still hesitant to touch the euro directly since it’s been persona non grata for so long. With violent movements overnight, why take the risk? Instead they are buying other securities that will benefit from a recovery in the region’s debt crisis.

Terranova, for example, is buying the PowerShares DB U.S. Dollar Bearish ETF and the CurrencyShares British Pound Sterling .

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