Bearish view on the EURO

Friday, November 28, 2008

Finexo warnings about potential volatility here as we come into month end during thin US markets have so far proved unfounded, as markets have barely moved over the last 24 hours despite a flurry of very ugly data out of the EuroZone yesterday (cratering November confidence levels) and Japan overnight (we looked at household spending, industrial production and small business confidence - we're note sure what that strange jobless rate number is all about). The tendency remains for equity averages to tick higher and risk aversion generally showing signs of fading slightly, though nothing looks convincing so far. Still, beware the end-of-month fix today, which could create a bit of hectic activity. US markets are open for a half day of trading today. The "Thanksgiving Surprise" of 2006 happened on a Friday, when EURUSD zoomed through 1.3000 for the first time in a long time. Though looking at the context of the 2006 move, it had been preceded by a very large move on Wednesday of the same week that was clearly applying pressure to the key 1.3000 resistance level. By strange coincidence, the 1.3000 level is also in play here two years later, and it appears that Euro is working itself into an either/or situation again.

We have made our bearish view on the EUR fundamentals clear, but let's see if the market is listening...any attempt back through 1.3000 and 1.3080 would put the bearish view on hold until/unless a strong reversal appears. 1.2800 is needed for the bears to get a better technical argument for a further fall. With the ECB meeting next week and EURUSD tracking interest rate differentials relatively well again, we will get a resolution to this soon. Continued attempts by equities to rally and a hawkish ECB would probably send the pair on another wave higher. Our preferred scenario, however, has the ECB finally forced into a more dovish stance, perhaps surprising on the rate cut size (as the overnight rate should clearly have been 125 bps lower than it is currently at least a month ago) and the broader market rolling back over into risk averse mode. In the medium term, we can't conceive of any scenario that spread between European 2-year rates and US 2-year rates (currently around 109 bps vs. 200 bps in mid September and lowest daily close at 90 bps in late October) from shrinking further towards parity.

Awaiting next week for important events

Next week sees a whole slew of central bank announcements and important economic data. The major US data includes the two major ISM surveys and the employment report on Friday, which unfortunately looks like it will be an absolutely terrible one, considering that consensus payroll expectations are already lower than at any point during the 2001 recession. The BOE, ECB, RBNZ and RBA will all announce rate cuts next week as well. More on those next week


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