Long-term trends can be difficult for traders to see in financial markets at times, and even more difficult to act on. Even as long term trends develop, the short term focus of what traders do makes them more inclined to look for inflection points than a continuation of an emerging move. Thus, as the S&P 500 has continued to march upward over the last four years, there has been no shortage of people predicting the next big collapse; everybody loves to pick the top. In the currency markets, due to the ultra short term nature of spot trading, this can be even more exaggerated. Sometimes, foregoing technical analysis and considering the big picture can lead to a clearer long term view. This is the case with the Euro at the moment.
It is tempting to look at the hourly Euro Dollar (EUR/USD) chart and conclude that a bottom has been found at around 1.31 and a retracement is coming. This may be the case, but if we expand our horizons somewhat and look at a weekly chart, the picture is a little different.
This tells a story of continuing lower highs and a return to the support at 1.20 looks distinctly possible. As I said, though, regardless of what the charts say, I believe we may be in a period of fundamental adjustment that will see a lower Euro generally over the coming months and years, and particularly against the US Dollar.
Post recession, the strength of the Euro has been based on the “best of a bad bunch” argument, and on relief that the currency looks less likely to come apart completely; neither one is a ringing endorsement.
As the other major currencies, the Dollar and the Yen, have been weakened by Central Banks pursuing growth via the effective printing of their currencies, the ECB has always kept a wary eye on inflation. The relatively controlled supply has given support to the currency. The suggestion that the ECB would buy short term bonds of troubled member States did much to calm the sovereign bond markets in Europe, with Spanish and Italian 10 Year yields dropping around 30% from their highs, but until now they have relied on the threat and have not made any significant purchases. Any such potential bond buying program is also limited by the ECBs mandate and by the political climate in Germany, the most powerful member state. A recent court case there challenged the ECBs right to buy those bonds, arguing that they had no authority to bail out the countries with problems. Should this be successful, the sharks will once again begin circling around the so called “PIIGS”, Portugal, Italy, Ireland, Greece and Spain. Whether the court case succeeds or not, the Germans have made it clear that price stability is their main concern, and the same should, in their powerful opinion, be true of the ECB. This focus on avoiding inflation is understandable given that hyper-inflation in Germany produced the unrest that facilitated the rise of Hitler and World War 2. The refusal to actually join the money printing party has kept the Euro artificially strong, but if recent murmurings of the Fed and BOJ are to be believed, that party may be coming to an end elsewhere. The focus of the world’s markets may shift away from the solution, the possibility of a bail out of sorts, and back to the problems.
The relief rally doesn’t need much explaining. When a currency gains support based merely on its continued existence, it isn’t hard to see that that support is a little fragile. I don’t believe that the Euro will implode and cease to exist, but I also don’t think that a failure to self destruct is a good reason to buy something.
It would seem then that two things, QE in the US and Japan, and “it could have been worse” have lent support to the single European currency. One appears to be coming to an end and the other is a terrible reason to buy something in the first place.
Whether you are directly involved in the FX market, or visit it occasionally via ETFs such as FXE or ERO, a short, long term Euro position may be a smart move, particularly as a hedge if you own Euro denominated stocks. The troubles of Europe’s Southern countries have been out of the news lately, but they haven’t gone away. There would seem to be little reason left to buy the Euro and sound reason to sell it. I expect the recent Dollar strength to continue and the recent drop in EUR/USD to develop into a full blown, long term trend.