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The foreign exchange market has not been behaving the way it should, and the EUR has been the most disobedient currency among the major currency pairs.
In July the German ZEW expectations index fell to a worse-than-expected 30-month low of -15.1, attributed to the European debt crisis. The single currency should have dropped, and it rose.
A few days later, the flash composite purchasing managers index for July dropped from 53.3 to 50.8, barely hanging above the boom-bust line at 50. Again, the euro rose.
So, with fundamentals not adding up, we’ll turn to technicals. However, depending on the time frame you look at, the EUR might be set to go up or go down. And, it isn’t easy to determine which time frame to use, as the forex market has been confronted by conditions not seen in the 37 years since the 1974 introduction of floating currency rates (and nothing has come close in the 12 years since the EUR was introduced).
In defence of a rising euro
If we examine the euro since it bottomed out in October 2000, it is easy to support its continued rise against the US dollar. Since October 2000, the EUR/USD has only spent four prolonged periods below the 200-day moving average, – four months in 2001, eleven months in 2005-06, nine months in 2008-2009 and nine months in 2010. This is a total of 33 months in 129, or a quarter of the time.
A linear regression channel (three upward trending bars, the lower one at support, the upper one at resistance and the middle one halfway between the two) has roughly defined an uptrend, aside from when the fx pair broke its support in 2010 until today, and this break was only 50% of the primary up move. Since 2008 the euro has been experiencing a choppy decline, though the single currency has broken out above that resistance barrier since, and has remained above it since April this year.
So we can infer that the market became infatuated with the single currency when it was introducted, and this infatuation overcame poor policy decisions, bad economic data and political turmoil. Even in the current situation with sovereign debt crises and an uncertainty about whether the single currency will even exist in five years, the euro’s fall is much milder than its original climb and it has retraced over 62% of the downtrend twice.
If we look at the up move from the low of June 2010 to the November 2010 and draw a line of the same slope from the current low, a case can be made for the single currency rising above 1.5000 by the end of the year.
The case for a downturn
Fundamentals argue that the euro should fall, considering the sovereign-debt crisis and the fact that there are no real solutions expected for several months. And, if we look at shorter-term charts, technical analysis can also back this up.
A strong resistance line can be drawn from the high of May 4, 2011, and a parallel support line brings the end-of-August range to 1.3500 to 1.43849. And, a 20-day moving average crosses above the 55-day moving average on August 10, indicating a potential rise. However the shorter-term average hasn’t risen enough to make a bullish case for the currency and has largely stayed below the 55-day moving average since May.
If we plot a trendline of the last big down move, (November 2009 to June 2010), and plot a second one at the high of May 2011, this indicates that the single currency could potentially fall below 1.2500 by the end of 2011. Conditions are similar – the first plunge occurred when the extent of the Greek debt crisis became clear to the markets and the euro declined following the intervention of the European Financial Stability Fund.
To conclude
History has shown that it doesn’t pay to trade against the euro in the long term, and it may rally again when authorities announce new measures to deal with the debt crisis. Europe also has anti-inflation and fiscal principles that long-term investors in the fx market appreciate, which means they are likely to view the sovereign debt crisis as a bump in the road.
That being said, there are many potential short-term short-selling profits to be made.
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