Euro Smackdown, Round 2

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 |  Includes: FXE, UUP
by: Wayne A. Corbitt

The European Union is in a world of hurt right now dealing with the excesses of their member countries. The situation in Greece has been all over the headlines during the last couple of months. While the media has tried to stir up fear over the Greek situation, the fact of the matter is that the market has already priced in a Greek bailout. Letting Greece go under is unthinkable at this point as the IMF and the EU are lining up with their wallets open. Now, however, it seems that we have a new contestant in the game of 'bailout roulette'.

From Forbes.com:

Portugal has to refinance euro5.6 billion of bonds by May 20, a day after euro8 billion ($10.8 billion) in Greek bonds matures. Some euro20 billion ($27 billion) of Portuguese debt comes due this year, most of it Treasury bills. The debt agency intends to issue debt worth up to euro10 billion ($13.4 billion) in the second quarter.

Two of the PIIGS (Greece and Portugal) have been exposed, which leaves three to go. With Spain, Italy, and Ireland lined up next, prospects look bleak indeed for the Euro over the intermediate term. The EU will have to keep the printing presses rolling 24/7 just to keep multiple governments solvent.

The chart of the Euro/FX Composite below shows just how weak the Euro is. Notice first how price has declined sharply from its November 2009 high as sovereign debt issues have emerged. The 14 period Relative Strength Index (a momentum indicator - in the middle pane) showed a positive divergence from February into March. While price made a lower low, the RSI did not. That usually forecasts a spirited bounce which clears out the weak shorts. The Euro couldn't even muster that, which is a testament to its weakness.

Next notice the broad consolidation pattern that has been in place since February. The best that the Euro could do was chop sideways following the steep two moth decline. The volume MACD (a representation of volume momentum - in the bottom pane) has been heading south which means that this consolidation pattern is close to resolving itself - but which way? For a hint as to which way it will go, take a look at the price pattern which is shown by the two red lines on the price plot. These lines show a support area in the 1.32 - 1.33 area along with a pattern of two descending tops. This is known as a descending triangle which is a pattern that is common before down side breakouts. As price has tried to rally each time off of the support area, upside momentum is weak and volume is declining, not good signs for the bulls.

Click to enlarge

Next let's have a look at a monthly chart of the Euro to see where support may be found should a downside break occur. In the chart below, notice that the Euro has been in an up trend since 2001. By connecting the bottoms along the way, an up trend line can be constructed which has acted as support in the past. A break below this long term line is confirmation that sentiment toward the Euro has changed. Right now that line is at the 1.30 level. Should that line break, next support can be found in the 1.17 - 1.23 area as demonstrated by the congestion area shaded in yellow on the chart. This is a zone where buyers and sellers have wrestled for control twice in the past and each time the bulls have won. If that level gives way, there is very little standing between the price of the Euro and par with the U.S. Dollar.

Click to enlarge

For those of you who have never taken the time to learn or appreciate the discipline of technical analysis - this presentation is not suggesting to short the Euro here. The table is set for a decline, but any new Euro shorts should not be considered unless 1.32 gives way on accelerating volume. This would show that sellers are in control and want to drive the Euro lower.

Disclosure: Long U.S. Dollar