After trading sideways throughout the Asian and European sessions, despite surprisingly positive European sentiment numbers, the euro came to life on the U.S. open to jump out of the previous 3-day range and settle 40 pips higher on the day. We see the euro as still being a bull over the intermediate-term, and consider the 400 pip sell-off in the first half of February as a correction. ECB Boss Draghi has proven himself a powerful central banker by engineering higher currency prices despite fundamental weakness in his banking system, and having to harness such a disparate constituency. Draghi's plan was a simple one: provide relieve for European banks by insuring that money being paid back to them is not at a lower exchange rate but at a higher one. Sophisticated speculators who borrowed euros in 2011 and 2102 and converted them to other asset classes, such as gold, or U.S. dollars, thinking they would repay the euros at a much lower rate are no longer looking so sophisticated. While Draghi and the Europeans took some pages out of the U.S. Fed's playbook re: using public sector funds to back-stop private sector debt, they kept interest rates unchanged, creating a positive carry trade against the greenback, which proved enough of a tax on speculators to back off on their short euro bets. The rally will also have the benefit of allowing euro lenders the opportunity to hedge their longer-term exposure at much more favorable rates than they were looking at just last summer.
While Draghi did his job well over the last 6 months in boosting the euro's value, the question is, will the market allow the euro to hold that value? We do not see the euro moving much beyond the current 2013 high at approximately 1.3700, but aren't prepared to bet against higher prices just yet. The 1.34 handle still may prove cheap near term, but 1.38 + would get our attention. We see nothing wrong with considering a possible short campaign just below the 1.40 level -- at the same levels we anticipate will see banks hedging their exposure.
The Australian dollar again shook off near-term weakness today to grind higher following the RBA minutes; of which our initial interpretation was "not bad." We still see last week's highs at approximately 1.0380 as good risk/reward point to set up shorts in-line with a bearish day to day pattern. We like risking 35 to 40 pips to make a potentially a lot more -- our downside target is 1.0100.
The Australian dollar is another example of central bankers' wishes trumping intermediate-term fundamentals. No doubt the Australian economy and banking system are on a more sure footing than Europe. But that alone is not enough of a reason for money to lie idly in much higher yielding Australian debt. The RBA and the business community it serves is not going to complain about a slightly lower currency price. In fact, the euro and aussie enjoy a symbiotic relationship. As does the euro and the U.S. dollar. Euro land needs a stable currency to augment their weak banking system, with a strengthening currency being a bonus; while Aussie businesses welcome a less strong currency as a reward for a sound banking system. And this isn't the 1990s anymore, where smart and gutsy hedge funds with the backing of good old-fashioned market fundamentals can gang up on central bankers. The current environment seems to be one where market prices are more a reflection of possible outcomes of successful central banker operations than of current business conditions.