euro finally rebounded last week after five weeks of consecutive losses.
The currency gained after German lawmakers approved their country's
contribution to a $750 billion bailout package, temporarily easing the
concern of a Greek default.
EUR also strengthened as European Central Bank (ECB) officials jumped to
its defense on Friday. ECB President Trichet denied the EUR is in
danger and asserted that it is a credible currency. ECB Governing
Council member Ewald Nowotny, head of Austria's central bank, took out a
full-page ad in an Austrian newspaper on Friday to reinforce that there
was no cause for concerns about EUR. These verbal interventions from
ECB officials were enough to install fears in the market that central
bank would intervene to stop the EUR to drop further. Given the huge
amount of EUR shorts, investors who had bet on the currency's fall
scrambled to buy it back on fears of intervention, especially those
impulsive shorts who had sold near the lows.
Squeeze Out vs. Bottom Out
As of Friday's closing, the single currency has declined more than 12
percent this year, despite last week's recovery. It tumbled to a
four-year low of $1.2143 last Wednesday, but has since rebounded
sharply, climbing as high as $1.2673 on Friday. The sharp recovery last
week has led some investors to speculate whether EUR has reached a
The EUR might be at a short-term bottom for now as investor positions
that are betting against the EUR remain at a high level. The rally last
week has cleared out some of these shorts, but the overall market is
still heavily biased on shorting the EUR. Data from the Commodity
Futures Trading Commission on Friday showed the net short position on
EUR fell only to 107,143 contracts from the record net short position of
113,890 contracts the prior week. EUR/USD could climb further towards
1.28 if these shorts are to be cleared out further to a normal level.
On the other hand, that does not mean the EUR cannot continue to fall.
Many long-term investors have sold EUR at a higher level and they are
quite comfortable maintaining their positions despite market volatility
and short-term EUR strengthening. These positions will not be easily
squeezed out as long as the euro zone outlook remains poor and euro zone
countries are struggling with their sovereign debt problems.
Back to Basics
Despite the bailout package, the fundamentals outlook for the EUR is
still poor. The German parliament's approval of the bailout is only a
first step towards containing the sovereign crisis from spreading to
more countries. European finance ministers supported calls for new and
tougher sanctions against countries that break EU budget rules. Policy
risk remains high ahead of next month's G20 meeting, where additional
financial sector regulation will be discussed. All these austerity
policies of deep public spending cuts in Greece, Spain and Portugal are,
however, expected to be negative on the outlook for growth and monetary
policy in the euro zone and will continue to exert pressure on EUR.
News this week that Germany will tighten fiscal policy faster will put
pressure on all other 15 euro zone members to take similar steps. This
will dim the outlook for growth, delaying ECB rate hikes even further
into 2011, adding another factor not to buy EUR.
What Direction to Intervene?
The EUR has fallen roughly 5.4 percent against the USD this month. Its
steep decline has cranked up speculation European officials may be
concerned about its level and might intervene in the market to buy EUR.
The ECB has not intervened in currency markets since late 2000 when
concerted actions with other central banks succeeded in putting a floor
under the EUR at 82 cents. This time around, central banks may be
concerned that EUR exchange rates are moving too fast, but it is
unlikely that G20 could come to agreement on the direction in which to
take EUR over the medium term.
Intervention would not solve the issues in sovereign debt as negative
EUR fundamentals have not changed in the medium term. The rebound in the
past few sessions is purely based on position squeeze and will not
last. So far, rebounds in EUR have merely been a correction to a steep
down fall, enabling investors to sell EUR again at better levels. The
EUR selling interest will persist as long as the structural problem of
EUR exists, rendering no reason for investors to buy the single
currency. I expect EUR/USD will decline again once near term position
adjustments in global markets have abated.
The views expressed in this column are solely
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or Silicon Valley Bank, or any of its affiliates. This material,
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