Euro Strays Away From Fair Value - Briefly

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

If you don't like this price, wait, because it will change. That is how the euro is trading has been trading today. Early in today's session, the euro was working higher, perhaps because Angela Merkel said higher interest rates were good for Germany. Trade in the euro had been been weaker, anticipating a reduced ECB rate, so this was unnerving to the bears. The EURUSD rallied close to the 1.31 handle and then got whacked, selling off about 100 pips.

The catalyst for the sell-off was comments by Goldman Sachs. They expect a 25 basis point cut in the ECB bank rate at the meeting on the 2nd of May. They note this drop is "largely cosmetic" and they feel it will have little impact on the economies of Europe. Goldman also reduced the euro area GDP estimate to -0.7% from -0.5%.

Earlier today, the Spanish unemployment rate was announced at a new record high, 27.16%. Under 25, the unemployment rate is 57.2%. The situation is so dire in Spain that many girls up to age 30 seek jobs in Ireland as au pairs, not for the money, but so they can improve their English. Then they intend to leave Spain and find an English-speaking job. It is hard to believe the populace will remain docile and adhere to the German requests for more austerity. As the weather warms, so might Spanish tempers.

In the U.S. tomorrow, we get the U.S. Quarterly GDP report. The last report was a positive 0.4%, but the average guess for this report is 3.0%. Strange is it not that we can get the large growth increase when almost all of the recent reports have fallen short of expectations? Well, the U.S. government has changed the way in which they measure GDP. They will now include research and development spending as a positive addition to the GDP. Further royalties from films, art, books, and the theater will be added into the number. The U.S. GDP will be computed in such a manner to show greater growth.

Granted, the U.S. Initial Jobless Claims number, 339K, was a friendly surprise, but most of the previous numbers did not indicate the economy was growing at the 3.0% rate. The media will feature the headline number, but will they note the changes? We doubt they will, and the market will trade the U.S. number of 3.0% and the euro area of -0.7%.

A major impediment to an economic recovery in Europe is the cost and availability of capital for the private sector. Addressing this, Goldman had these comments:

"Reducing funding costs in the periphery, despite signs of weakness in the core, should remain the ECB's main focus. As Mr Draghi has said repeatedly, the Governing Council is thinking "360 degrees" on this topic. But Mr Draghi and other GC members have also increasingly stressed the limits of what the ECB can do on this front. If, for example, it is a lack of capital that is holding banks back from lending, there is not much the ECB can do. Rather, it is governments that would need to create the conditions for a recapitalisation of banks. We would expect the ECB's demand for government actions to become even louder after a rate cut."

Once again, there appears to be some support around the 1.30 handle. Eventually, the European turmoil will weigh on their currency, EURUSD (FXE, UUP, UDN) and we expect a return to the 1.28 area.

Tomorrow is an important day for the Japanese yen. Early in the morning, there will be several measurements of the Japanese consumer price index, and all are expected to be negative. Later tomorrow BOJ Governor Kuroda will hold a press conference to announce their various plans. The USDJPY has been on the cusp of a breakout above the 100 level. Failure to give the yen bears a reason for their stance might cause some to cover short positions. It should be an interesting Friday.

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.