Can The Euro Suffer A Butterfly-Like Effect?

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 |  Includes: ERO, EU, FXE
by: FXstreet

The euro has produced little excitement in the last couple of days, with the price depressed within its 1 cent range while awaiting new cues to increase price activity.

If any U.S.-based traders had turned off their charts last Thursday, February 14, to take a long weekend away from the markets on Monday's U.S. President's Day- only to be turned back on today- we assure you not much has been missed out. Trader's timidity to commit large capital remains the norm until additional fundamental drivers are known.

Yesterday (Monday), we warned that the euro is facing worsening fundamental headlines coming from varies angles, forcing some long-held positions to be liquidated, as sellers also step in trying to break a key level of support at $1.33.

Last week's contraction in France and Germany's economies has made a very negative impression toward the near-term perspectives on two of Europe's main economic engines. As Ivan Delgado, head of Asian editors at FXstreet.com, said

there is a thin line that separates events linked to euro moves still classified as corrective in nature, to potentially be the trigger that constitutes a structural change in the still daily EUR/USD uptrend.

While Monday's prices were kept in check by the equality of forces between buyers and sellers at the infliction point $1.33, the news flow was, again, not supportive for the euro, with the head of the European Sovereign Ratings at S&P, Moritz Kraemer, stressing the danger of Spain, France, Italy and Portugal being downgraded this year.

The euro status may somehow resemble what in chaos theory is known as the butterfly effect, understood as a small change in events at one place leading to a much larger unfolding of differences to a later state.

As Wikipedia describes it: "The name of the effect, coined by Edward Lorenz, is derived from the theoretical example of a hurricane's formation being contingent on whether or not a distant butterfly had flapped its wings several weeks before."

One can not help but feel that if the eurozone keeps providing this type of headlines, a rethink on one's strategy may be necessary. How many negative news would result on the expression... enough is enough to play this market long? Put differently, how many additional times can Europe continue flapping its wings till a hurricane of sellers steps in?

As Kathy Lien, co-founder at BK Asset Management, notes:

If this week's economic reports and European Commission's growth forecasts suggests that this risk has increased, then the euro could be in big trouble.

There is also another ticking bomb as Italian elections approach, which could create a big problem for the euro over the next 2 weeks, Kathy says. The best case scenario would be a coalition government between center leftist with Mario Monti's centrists, yet as Kathy notes, "the elections are close and can still go any way and the worst case for investors and the euro would be a win by Berlusconi because he plans to abolish unpopular reforms..." thus "increasing the risks of a downgrade.

Today, the main risk event keeping traders certainly on the edge will be the German IFO, where estimates are pointing for an improvement in February compared to last month. A positive read-out will be a confidence booster for deprived longs in order to revive the still daily trend. On the contrary, disappointing figures, depending on the deviation between actual data vs. expectations, may see heightened risk for a potential break of $1.33

If such a bearish event were to occur, according to Fan Yang, independent currency analyst at FXstreet.com, "it would open up the $1.3255 support, as well as a rising trendline that goes back to July 2012 when the bullish trend started." However, he warns that only a break below $1.3150 is likely needed "to extend the bearish scenario beyond a correction against the daily bullish trend." To the upside, in case an IFO-inspired rise is seen, "a push above $1.34 may neutralize the bearish outlook, yet a push above $1.35 is probably needed before reviving the bullish outlook."

Kathy shared some insights with FXstreet.com on the upcoming IFO report, with the analyst being seemingly optimistic on the outcome:

Based on other economic indicators such as factory orders and industrial production, Germany has had a steady start to the year. The Bundesbank also said that the German economy will return to growth in the first quarter.

To sum up, while it may be hard to single out one event as the onset for a sustained euro liquidation, and with still no evidence of such gloomy prospects, investors should nevertheless be watchful as the accumulation of wing flaps by this dangerous butterfly machine called the eurozone has lately gone a bit tense. Will it eventually set the hurricane in motion?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.