Last week, the central bankers in both the ECB and the UK announced money in Europe and the UK was going to remain loose for an extended period. Prior to the latest meeting in Europe, the Fed's Bernanke had jolted the global debt markets with musings about the possibility they might taper off their monthly expansion of their loan portfolio.
In response to the Bernanke tapering episode, Ambrose Evans Pritchard had these comments in The Telegraph:
"The Bernanke Fed is playing with deflationary fire
I hope the Fed knows what it is doing.
It has chosen to tighten monetary policy even though core PCE inflation is actually lower right now than it was when the Fed previously thought it dangerous enough to launch further QE. America is one shock away from a slide into outright deflation, and the eurozone is half a shock away."
Yesterday Bernanke calmed the fears of those who felt the tapering of the monetary growth could commence as early as September. While there are proponents for tightening on the Fed Committee, they do not have the votes to change policy. Bernanke assured us that the easy money policy will be with us for quite a while.
Remember Bernanke's second term as Fed Chairman ends in seven months, and after ten years, he wants out. Yesterday Bernanke acknowledged there are employment numbers that must be achieved before tapering can commence; the easy money may be with us after his departure. Replacement candidates most mentioned as his replacement are Janet Yellen, currently Vice Chairman of the Fed's Board of Governors, and Lawrence Summers, a former member of both the Clinton and Obama administrations. My guess is they would both continue the loose money policies of Bernanke.
The Bernanke comments fueled a strong rally in equities and caused a euro rally from 1.2765 to over 1.32. In our most recent COT report, it showed that specs had moved to the short side of the euro. We suspect some of these traders were forced out in yesterday's short squeeze. The change in the open interest at the CME does not show much liquidation, however, the real strength came after the 5 p.m. cut-off.
Where do we go from here? Looking at the weekly chart, we have an engulfing candle that covers the last two weeks. This must be respected, but so too must be the fundamental inputs coming out of Europe. The Med countries from Greece to Portugal are all in trouble. Germany's cure to the economic malaise, austerity, has only made things worse.
In the most recent article by Evan-Pritchard, he says:
"The ECB is allowing "passive tightening" to occur. Mario Draghi's attempt to talk down yields with his new policy of forward guidance is spitting in the wind. The ECB needs to turn on the monetary spigot full blast - like the Bank of Japan - to head off a slide into deflation trap and enveloping disaster by next year. This is not going to happen."
The US economy may not be exhibiting great strength but it is mustering more growth that Europe. Italy, with €2.1T of debt, yesterday sold €3.39B of 3 year paper at a yield of 2.33%. This exceeds the US rate for three year paper of about .7%, and the German ten year rate of only 1.65%. Compound interest on €2.1T quickly adds up. This week S&P reduced the rating on Italian debt to BBB, two categories above junk.
The fundamentals do not seem to favor the euro, (NYSEARCA:FXE) but at the moment, the market acts firm. We are bearish on the euro, but the market actions suggest it is best to wait and sell later.
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.