Friday, 30 August 2013

First Euro Sell-Off In Weeks

Ralph Shell, Excel Analyst

For the first time in seven weeks the EURUSD has had a decisive sell-off.  After stumbling Wednesday, closing at about 1.3340, the slide continued yesterday (Thursday), all the way down to 132.20. 

The catalyst for the sell-off appeared to be good US economic data.  The weekly first-time unemployment was as expected, 331K, and the Quarterly GDP (Annualized) was reported at 2.5% better the the 2.2% guess.

Another driver in the overnight news was the cooling of rhetoric regarding the civil war in Syria.  Wednesday, Western leaders said the evidence was conclusive, Assad has used nerve gas on his people and deserved an immediate response.  Thursday, the New York Times and the AP both warned more time was need to reach a conclusion, providing cover for the administration to rescind previous hawkish plans.

There is also the concerns of Parliament and the House of Representatives.  Both bodies need be informed, and military action by the US is supposed to be approved by the House.  So much for a Thursday-night missile show, but bellicose weekend war talk remains likely.

The steady stream of good US numbers probably means the Fed's taper is about to commence in September.  Should next week's US Employment number and the NFP confirm the recovery is continuing, the taper talk will get louder (the unemployment rate is forecast to remain unchanged at 7.4% and the NFP is estimated to be 175K).

Some of the USD strength may have been as a result of safe-haven demand as the world has taken sides and made threats over the Syrian situation.  Perhaps the Syria haven-buying will slow next week but strong US numbers should help the USD.

Should the Fed says they are beginning the taper, reducing their monthly purchases of bonds from $85B to say $75B what will result?  Certainly this would favor the USD versus other currencies, but the Fed's actions will impact global markets. 

Evans-Pritchard had some profound comments in Thursday's Telegraph.  The impact of the Fed's tightening will result in the contraction of the BRIC economies.  In the 1980's, when Volcker tightened the money supply, the emerging markets were less than 15% of the global GDP.  Now, according to IMF data, emerging markets account for half of the world's GDP.

"The big risk is that Fed tapering will spark a rush for US dollars. That is when the Fed will stop being complacent," said Lars Christensen from Danske Bank. "Central banks around the world think they have been doing something they shouldn't do with all this stimulus, and they want to unwind it as quickly as possible. But the danger is that they will go too far and trigger a relapse like 1937."

It is Evans-Pritchard's contention:

"The Fed has a duty of care to emerging markets, since its own hands are hardly clean. Zero rates and quantitative easing were the cause of dollar liquidity flooding these countries. It was the biggest reason why net capitals flows into emerging markets doubled from $4 trillion to $8 trillion after 2008, much of it wasted in a late cycle blow-off ... One cannot blame the US for the failings of these countries, yet Ben Bernanke and his successor will still have to live with the consequences. Globalisation has entrapped the Fed. Like it or not, the Fed is the world's monetary superpower."

One of the age-old adages is "you do not fight the Fed."  Once the taper starts, it is likely to continue.  Trillions of US Dollars, available at near-zero percent that had gone abroad, yielding shopping in the developing world, will head home.   

Click to Enlarge EURUSD Weekly Forex Chart

If we look at the daily EURUSD chart, yesterday was the first day we traded at the bottom end of the Bollinger Bands since early July when the low was close to 1.28.  The weekly chart has had seven weeks of unchanged or higher markets; it looks like this will be the first lower week since the middle of July.

Click to Enlarge EURUSD Daily Forex Chart

The Summer has been quiet in Europe, perhaps in respect for Frau Merkel's political campaign.  Once re-elected, problems will resurface.  We note Merkel said it was a mistake for Greece to be given entry into the EU, this past week.  Greece needs more money, quickly, so this may be the first post-election problem.  The list of EU problems continues, and we expect they soon will be making headlines.

Our preference is the short side of the EURUSD.  We note that during the last six weeks, our COT studies show the specs have covered 65K contracts of shorts, and gone long 43.7K contracts.  This shift of positions no doubt was partially responsible for seven weeks of higher markets. We prefer to try the sell side if we recover to the 1.33 level, be we may adjust the entry level next week.
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