Thursday, 25 July 2013

Do You Prefer the Euro or the Pound?

Ralph Shell, Excel Analyst

Excel Markets Forex Demo Account Trading ContestThere was some good economic news coming from Europe yesterday, Wednesday, 24 July.  For the first time since the report from February 2012, we had a score above 50, which is supposed to indicate the economy is growing.  The EU Composite came in at 50.4, up from 48.8 last month.  With the EU Manufacturing 50.1 and the Services Index 49.6. the math involved in achieving the Composite Index eludes us, but markets looked past this. 

This good news had positive results.  European bourses firmed and yields on core European bonds increased.  By the end of trading day, the German 10-year was priced to yield 1.64%, up 9 basis points.  Likewise, the UK 10-year gilt was up 9 basis points, and the US 10-year was up 10bps (the current US Treasury auction may be the primary reason the US yields are up - US yields have a peculiar way of going up prior to an auction and then selling off.)

Toward the end of the trading day, German 10-years were priced to yield 1.64%.  This is significantly less than the yield in Britain, 2.39%, or in the US, 2.61%.  This raises the question, why are the German yields so much lower than those elsewhere? Is money invested in Germany, a safer place than the UK or the US?  If that is not the case, then, can we assume the European economy is lagging and recovery from their current recession will be delayed?

Later today, Thursday 25 July, we get additional economic data which may provide some fundamental guidance.  First, there is the new estimate of the Spanish Unemployment Rate.  Recently, the number has been 27.2%, and is expected to stay at the same level.  An hour later, the EU M3 Money Supply will be released.  This is the broadest measurement of the money supply and is expected to show a 3% increase on a year-to-year basis.  Should the M3 number fall short of expectations, this probably means the ECB will need to commence with additional monetary stimulants. 

Shortly after these numbers are released, we get the UK GDP Quarterly and the yearly numbers.  It is expected the GDP grew in the last quarter at 0.6% up from the previous estimate of 0.3%.  For the yearly comparison, the estimate is up 1.4%, an improvement from the previous increase of 0.3%. 

If these numbers play out as forecast, it appears the British economy is much stronger than the EU.  This should mean the pound will outperform the euro, but there are other things to consider.  For the last month, the euro had gained over 200 pips on the pound, from under .85 to over .87.  While the British economy has been growing, the EU has been rewarded because there were no major problems, not because they had found solutions to existing problems.

Click to Enlarge EURGBP Weekly Forex Chart

Looking at the COT Report, there may be another reason to buy the pound and sell the euro.  That report shows the specs are big shorts in both the euro, 65.5K contracts versus 61K in the pound.  But the euro with 283K contracts open is a much larger contract than the pound with only 175K open, so the spec has a bigger short percentage in the pound.

Finally, would you rather own 10-year gilts yielding 2.39% or the German bunds at 1.64%?

Click to Enlarge EURGBP Daily Forex Chart

We think that the EURGBP (FXE FXP) has a chance of once again trading under 85.  Again, please manage your money safely.
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