article 3 months old

The Buoyant Euro Raises Its Head Once Again

Currencies | Nov 29 2011

By Kathleen Brooks, Research Director UK EMEA, FOREX.com

So risk is back on and all is good. Today’s price action has seen EURUSD jump back above 1.33, although it failed at 1.34 and eventually slid back to below 1.3320, but European stocks have seen the biggest moves: The Eurostoxx 50 index was up more than 5% today led higher by Europe’s banking sector, which jumped a massive 4.5%.

I have heard a lot of talk today about short-covering. That washes with FX, but not with stocks – the reason why is that there is a short-selling ban on French banks, which Paris extended earlier this month. So if you can’t short a bank why is Societe Generale up more than 7% today? There are a couple of reasons: 1, people think this crisis has truly turned a corner and the EU summit on 9th December will be the first step on a long road to recovery for the currency bloc; or 2, people assume that the short-selling ban will eventually be lifted and they could sell the stocks on in the future for a higher price than they bought at.

It’s probably a bit of both, but this situation doesn’t give me hope that we are in a new paradigm quite yet.

The bond market even moved with overall risk appetite today: we saw Italian and Spanish yields fall and German yields rise. One reason for this is that the salvation of the Eurozone is a zero-sum game: either Germany bails the entire currency bloc out (hence its yields are rising) or the currency bloc collapses.

However, we take our lead from the bond market and Italian yields continue to show signs of stress. All of its curve is now above 7% – a totally unsustainable situation, even if 2-year yields have moderated after hitting a fresh record high earlier of 8.12% this morning. This smells of ECB intervention to me, or the campaign by Italian soccer stars to encourage Italians to buy government debt is having incredibly fast results.

The big test for the market is tomorrow’s Italian bond auction. Rome is trying to sell EUR8bn of long-term debt. Although the market may be able to rally with Italian yields above 7%, make no mistake this is an unsustainable solution and too many auctions at this yield will be a one-way street to the IMF for Rome.

But what about the euro? It’s never really collapsed during this crisis and although the speculative community are short the most number of EURUSD contracts since mid-2010 (according to CFTC data on Bloomberg) the “real” money market must be happy to hold euro.

The euro has lost the bulk of its drivers this year: its stable political system has been exposed as a myth, yield differential etc., but the central bank reserve diversification theme is still propping up the euro, which has not played out yet.

This leads us to a couple of conclusions:

1, European banks are still as exposed to bad news as ever. Today’s move could be temporary and fuelled by buyers looking for bargains then hoping to sell on at better levels, thus it may not last.

2, EURUSD needs to break above 1.3415 – the Tenkan line on the Ichimoku cloud and a key resistance level – before we think EURUSD has turned a corner, until then 1.3150 early Oct lows remain in site.

3, Risk is vulnerable. There are some key event risks coming up over the next couple of weeks that will be pivotal for risk sentiment. We could be on the right path to sort out this crisis, but until these events pass we don’t know if we are on the right path, so it could be a choppy couple of weeks…

– Italian, Belgian and French bond auctions this week

– EU finance ministers meeting tomorrow and Wednesday

ECB meeting next Thursday

– EU leaders meeting next Friday

– Deadline for expanded EFSF by mid-December, which seems like a bad joke at this stage…

Some charts to ponder over:

EURUSD swap rates tend to track euro crosses closely. This measures the amount people are willing to pay for euros in 12-months’ time. This remains at its weakest level since the start of the year, and continues to point lower. Thus, today’s price action in FX could be short-covering only with people pricing in the slight chance the Eurozone crisis is sorted out soon and do not want to be caught the wrong side of any potential rally. Hence, we believe that nothing has fundamentally changed in the Eurozone and the euro is still looking weak.

The rate spread: we mentioned that the yield differential has been moving against the euro’s favour for some time now, but could that be turning a corner? German bond yields are rising relative to their US counterparts, which has coincided with EURUSD strength. We would point out that in this environment rising bond yields in Germany are not a good thing: fuelled by last week’s failed auction and the prospect that Germany is on the hook to bail out the entire Eurozone by itself. But, we are in an extremely low yield environment so, even with the back drop of the Eurozone crisis, rising yields on German debt may be appealing. However, if we see days like today in equities then US bond yields could surge higher… we will be watching this closely.

PLEASE NOTE THAT THESE ARE BLOOMBERG CHARTS AND DON'T REPRESENT PRICES OFFERED BY FOREX.COM

The views expressed are the author's, not FNArena's (see our disclaimer).

Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. 

Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that FOREX.com is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. FOREX.com is regulated by the Commodity Futures Trading Commission (CFTC) in the US, by the Financial Services Authority (FSA) in the UK, the Australian Securities and Investment Commission (ASIC) in Australia, and the Financial Services Agency (FSA) in Japan. 

Technical limitations

If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms