Some Forex Observations - What Is Next?

Includes: FXB, FXE, UDN, UUP
by: Ralph Shell

It seems like Cyprus has been the center of attention for the entire week. This tiny country has had the reputation of a financial center, which, as such, accounts for 25% of the country's GDP of around €20B. If financial centers are going to remain viable, stability and trust are needed. Each new story about the Cyprus insolvency serves to tarnish the country's reputation as a reputable financial center, increasing the probability of a messy ending.

The future is bleak, but this is not new. The three biggest financial institutions, according to Der Spiegel, had a valuation of €2.4B in the fall of 2011. Now the value is down to €500M, so investors have already taken a big hit. Deposits, according to statistics from the same source, were estimated to be €68B, with about €25B from Russia and the Ukraine. Why depositors would deposit such large sums in banks with such dodgy reputations is a good question. Maybe it was international hot money, as alleged, better off there than elsewhere.

It should be obvious by now, this country is too far gone to recover. There will certainly be some collateral financial damage with dramatic individual tales of woe, but it seems to me the markets will be relieved the drama is over, and there will then be 16 countries with a single currency.

It seems to me the trade in the euro this week has been cautious, respectful of the uncertainty caused by Cyprus. The Sunday night sell-off was exaggerated by liquidating trades, and has since labored back to fill that gap. Resolution of the Cyprus uncertainty, regardless of the outcome, should be cause for a rally in the EURUSD (FXE, UUP).

If the EURUSD trades to the top side of the 1.30 handle, this might set the stage for a rally above the 1.31 area. The European data is light next week, but not so in the U.S. On Tuesday, there is a Durable Goods report, a U.S. Confidence Report, and a New Home Sales report. On Thursday, there is a U.S. GDP Report. Most of the U.S. reports have been coming in as expected or better. We think that good U.S. news, if received, will give us a selling opportunity in the EURUSD.

Yesterday we published an analysis of the trade for the past quarter in the currency futures. The British pound, we found quite interesting. In the previous three months the GBPUSD traded from a high of 1.6382 down to 1.4831. This was quite a move, and speculators did not do a good job trading it. Around the high, according to our COT report in late December, they were long over 60K contracts. At the low end of the move, they were short, in the last report, 79.3K contracts.

This is not to imply they all bought at the top and sold at the low. Certainly this is not the case, but the market is quite short now, and the open interest in the futures at 214K exceeds that in the euro.

Lost in the twenty-four hour coverage of the Cyprus affair was the release of a new British budget. According to a Market Watch story, an S&P analyst calls the budget a "pretty good" policy mix. He said:

"The U.K.'s austerity measures aren't chiefly responsible for its sluggish economy, which is being dragged down more by weakness among its trading partners, a top analyst at Standard & Poor's Ratings Services said on Friday.

Moritz Kraemer, analytical manager for S&P's sovereign ratings group covering Europe, the Middle East and Africa, gave a thumbs-up to the overall policy mix being pursued by U.K. authorities. He blamed sluggish economic conditions on weak external demand rather than government-imposed spending cuts. "

With the market extremely short in the pound, a little good news might send the GBPUSD higher. The British budget did include a penny tax reduction in a pint of beer, however, this is not enough good news.

The chart in the pound looks like it is making a bottom. On March 12th, the day when we printed the low, the candlestick was a small "hanging man" doji. This often is the signal of a reversal of the recent trend. Since then, we have had a recovery back to the 1.52 handle. The MACD on the daily chart has also given us a buy signal. Pick your entry point here, and as always, manage your money.

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.