Hot Topic – EUR/USD – Did Fed start a new EUR/USD trend ?

EUR/USD (1,2975): Last week I was waiting for the next hurricane, but it was a big surprise for me that Fed should be behind it. I have long argued that the market long term will judge the US debt very negative sending the greenback lower. Last week we got a feeling for it as the dollar index had the steepest weekly drop in 24 years. My problem is that it was a surprise and conflicts with my short term view on EUR/USD.

A Fed purchase of T-bonds as quantitative easing was the next step in Mr. Bernankes “helicopter speech”, where the global financial community showed “thumps down” by selling the greenback. The lower yield on US assets of course also drags down the Dollar. For those who might not recall the whole speech, I will just mention the 4^th and final step. It is that Fed buys foreign bonds like for example German bunds. As Fed only has very limited currency reserves they would need to sell their own currency to buy EUR. I had difficulties to imagine that Fed would announce to buy T-bonds at the current interest rate level, but the 4^th step is beyond my wildest imagination.

With the current general relief in several markets and the higher risk appetite the CEE concerns are down played right now. It also means that the downwards pressure on EUR from this concern has faded out. The prior recommended downwards play through FX options wont materialise right now, and the option premium is very unfortunately lost. Due to the Fed surprise, the EUR/USD sentiment has changed to “buy on dips”, but due to the surprise I have difficulties to fine tune it. I would say, that a dip is 1,3300, but as I trying to get a feeling again, it can be that the market is more bid than I expect – i.e. other participants are bid at higher levels than 1,3300.

The CEE related problems will return, when reality returns to the market. But other underlying forces are out there working as well. Should Fed one day decide to use the 4^th step as mentioned above, then EUR/USD will go straight up in 2,0000. It would as a side effect cause the explosion of the common Euro Zone currency within less than a month – it will work as an external chock that can’t be absorbed.

But the Euro will suffer from other internal factors that currently seem to be forgotten because the financial markets are in the happy mood. Friday, the German CDU politician Mr. Otto Bernhardt really gave us some colour with his wonderful comments. I think he gave some statements that he might did regret afterwards. Based on his position as Member of the Parliament and CDU’s speaker of fiscal policy, I would judge that he has some insight in internal reports and the work on EU level.

Mr. Bernhardt said that, ECB holds a rescue fund that can be activated within 24 hours to bail out Euro-in members, ECB later denied it (the help would come in form of loans Mr. Bernhardt said). He also believes that it is more likely that the rescue fund will be utilised than not. I that context he mentioned Ireland and Greece as the most possible to borrow from the fund (i.e. go bankrupt) – later denied by the whole European community. Mr. Bernhardt later tried to adjust his comments, by underlining that a Euro-in country can’t go bust because the Euro would collapse. That point is fair enough, but the detailed information he gave didn’t come from pure fantasy.

Monday China suggested to use a globally common reserve currency, the SDR. It’s another sign that they would like to diversify but it would be easier if the world agreed on that (many countries let their currency reserves reflect their respective trade weighted indices, so the idea might not fit all countries). Anyway the SDR basket is 44% USD, 11% JPY, 11% GBP and 44% EUR, meaning a significant need for Euro’s if the Chinese plan came together.

The risk is not a global agreement but that China starts to reduce USD holdings and to increase EUR holdings, they have advised to do so for about 1½ years ago.

As a counterweight we have European growth dropping like a stone. Just today I saw one changing the 2009 German GDP growth forecast to possibly -7% (yes, minus seven….). Then it doesn’t help that the German GDP will grow with 0,2% in 2010 – it’s below the statistical error…….

Ok, so what is the conclusion on all this and the according strategy?

Short term the US housing data Monday to Wednesday might help the greenback and even the personal income (exp. -0,1%) and personal spending (exp. +0,2) could support. Funny enough, I have the feeling that if the PPIP news are well received it’s also dollar supportive. It explains the entry level at 1,3300 if I should take a position. As it is too early with the big investor depression about the huge US debt, the position will not be the fundamental one. Therefore I would choose a stop loss at 1,3000 and very likely an exit at 1,4000, maybe even a turnaround at that level.

The reason is, that when reality comes back to the market then the Euro negative factors will dominate for a period. These are the CEE problems, Euro Zone growth deteriorating and the collapse of the Euro. The sell off will be 10%, starting just after Easter.

Target: Entry level 1,3300 with stop loss 1,3000 and target 1,4000 (possible turnaround level).

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