Tuesday, 11 June 2013

Can the Euro Rally Continue?

Ralph Shell, Excel Analyst

June has been a good month for the euro and the bulls keep taking money from the bears.  To date, the EURUSD (FXE) has been moved up around 300 pips. The daily chart suggests there may be more. 

Europe's economic malaise had attracted an abundance of sellers in the euro, with concern the crises would continue.  Recently, Evans-Pritchard offered this opinion in the Telegraph.

"...the eurozone is sticking to the same mix of self-defeating contractionary policies that have tipped the region back into a double-dip recession, with seven quarters in a row of falling GDP, soaring unemployment, and an ever-starker divergence with the United States."

According to our CFTC Commitments of Traders (COT) analyses, the highest speculator net short in the euro went up to 109,257 contracts on the 28th of May.  In the most recent report, the net speculative position has been reduced to 74,832 contracts.  During this period from May 28th to now, the EURUSD has consistently traded higher giving the appearance of an orderly short squeeze. 

Click to Enlarge EURUSD Daily Forex Chart

One of the reasons the EURUSD has rallied from last Summer's low under 1.21 has been the pledge by ECB President Draghi to do whatever it takes to preserve the euro - and why not.  If the euro zone were to come apart, there might be less need for a central banker.  In his capacity, Draghi makes a fat salary, €374,124, far more than Bernanke's $199,700 (€151,000).

Credit Draghi, however, for successfully bluffing the bond market.  At that time, Spanish ten-year bonds were trading to yield over 7% and Italian bonds over 6%.  His pledge to do "whatever it will take" tamed the bond market, and Spain and Italy were able to continue issuing government debt.

The bond-buying program, perhaps hundreds of billions, alarmed the Bundesbank, as well as German politicians.  If something went wrong the German taxpayer would be on the hook for the billions.

"...the Federal Constitutional Court declared: "An acquisition of government bonds on the secondary market by the European Central Bank aiming at financing the members' budgets independently of the capital markets" is "prohibited ... Bailing out countries is not part of the ECB's mission," says Freiburg law professor Dietrich Murswiek, who represents Gauweiler's complainants."

Tuesday in Karlsruhe, described in a German travel guide as a forward-thinking, cultured city, the German Constitutional Court is taking testimony on the dispute, and testimony will continue Wednesday.  The powerful Bundesbank President, Jens Weidmann said:

"In a statement submitted to the court, he chose clear and critical words: "In view of the fact that it still consists of sovereign nation states, the current composition of the monetary union cannot be guaranteed -- at least not by the central bank."

Don't expect any conclusions from the Court's hearing very soon.  Remember how President Obama called his European friends, pleading for calm ahead, of his election in November?  Chancellor Merkel will try to keep a lid on this too, as well as other potential distractions ahead of her election in three months.

After the court findings are completed, it would not surprise me if Draghi would effectively lead the cheers for the euro.  At the same time the judges will do what they do best - silently deliberate.

Despite the slow growth and the high unemployment, this may be a situation when the euro can rally further.  At least until some more shorts get covered.  It would not take much to get this pair above 1.34.  Again, mind your money.
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