Tuesday, 13 August 2013

Is the Euro Rally Over?

Ralph Shell, Excel Analyst

Is the Euro Rally Over? For the past five weeks the USD has lost to the Euro (FXE, EURUSD, UUP UDN). From a low of around 1.2755, the market climbed to almost 1.34.  Generally, the reason given for the rally was things were not so bad, and the European debt crisis was over.  Next, the confident euro bulls asserted, the recession was over, and we were on the cusp of positive growth, all be it small.  But is this bullish chatter really worth a 640 pip rally?

Euroskeptics have been around for years, aware that the euro was a currency ill-suited for all members.  Rather, it was  was a recipe for economic imbalances and resulting conflict.  Why then, they wonder, has the Euro even survived, let alone be so strong?

In the Telegraph yesterday, Jeremy Warner offers an explanation:

"One of the mistakes Anglo-Saxon commentators such as myself have made in forecasting the imminent demise of the euro is to focus only on its economic contradictions. If these were the sole determinants, then the euro would indeed already have lost a number of its original participants.
But for most, the single currency is built on political idealism – belief in common destiny and shared responsibility after the troubles of the past – and this has proved a far more resilient force than I appreciated. Unfortunately, it has also failed to generate the necessary resolve to do something about Europe's economic malaise, which won't, as policymakers seem to think, simply go away of its own accord given time, fiscal, and structural reform in afflicted nations."

The tranquility over the past five weeks in the euro caught some traders on the wrong side of the market.  If we use the COT Report for position analysis, we note on the July 6th report that large specs were short the euro by 40K contracts.  In that most recent report, the large specs have gone the other way, and are now a modest long of 2K.  Thus, part of the recent euro strength was short covering.

The trend this week seems to have changed from Euro to USD buying.  The Euro bulls tried to use a EU ZEW M/M Survey of Economic Sentiment to tout their case yesterday, up to 44 from 32.8 last week, but this report was trumped by a positive US Retail report.

That report showed US Retail Sales, excluding autos, was up a healthy 0.5%, a little better than expected.  With each new positive US report, the cheers from the proponents of tapering get louder.

Today, we may see if those who think the European recovery is under way are right.  A positive outcome is forecast for the Q/Q French GDP, 0.2% compared to -0.2 last month.  Later, we get the EU GDP which is expected to be the same as the French. Yearly EU GDP is forecast to increase to -0.8, up from -1.1 for the last report.  The market is expecting good numbers and should they fall short of expectations, there will be selling in the euro.

Monday, Mark Grant, courtesy of zerohedge, had some interesting comments:

"It was the sadly-departed Loews Chairman, Larry Tisch, who told me early on in my career, "forget what they tell you; just look at the numbers." I then point to what the Federal Reserve Bank is doing. As of July 31, 2013 they have parked $1,157 billion in foreign banks as compared with $1,112 billion in U.S. banks. To me this is a telling sign. The European banks are in trouble and the Fed is propping them up. One of the consequences of tapering, when it comes, may well be less available cash for this task and then the cracks in the European banks may well blow into gaping holes."

Mark Grant is an eloquent writer, but in my opinion, often veers into the Chicken Little crowd (those who believe the sky is falling.)  But there are reports many European banks are under-capitalized.  Further, quality collateral needed to borrow from the ECB is in short supply.  The last thing Europe needs is a strong currency, rising interest rates, a contracting money supply, and a tepid economic recovery.  What if Grant is right? 

It looks like the rally in the Euro may have played out.  The 1.34 handle has been proven resistant before and looks like it might be again.  It is hard to calculate a downside target; however, we started under 1.28.

As an afterthought - it is a well discussed topic - Merkel does not want any EU crisis until after she is safely re-elected.  But this can work two ways - are there not some people or governments that do not want her re-elected?  There are those who think the euro is for the benefit of the Germans, and austerity, as a policy, hurts them.  Any chance they will act up in the next six weeks ahead of the election?
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