Once again, when ECB President Draghi talks, the market listens with respect. The pundits claim the phrase "comfortable taking action in June" is what got the market running to the downside. Probably there is more at work than just a phrase. But the threat of pending prospective negative market inputs coming from a central banker who has done it all took the starch out of the market.
What followed was a key reversal day in the parlance of technicians. The EURUSD exceeded the previous high for the year, trading at the highest level since October of 2011, no small feat. Then the market reversed, selling off about 150 pips from the high. Making a new yearly high and then closing lower is called a key reversal, a notable event. Extremely high volume confirmed the importance of the reversal.
While it is not possible to get a tally of the trading volume in the forex market, we do have the daily volume in futures at the CME. They reported the daily trade was 359K contracts, well exceeding the open interest of 271K. When the daily trade exceeds the open interest in any market, this often confirms the most recent market move is over. The continuation of the sell-off on Friday was further evidence, the market was changing drivers.
The question arises, however, when did the trend start? The monthly charts look like the bottom was made at about 1.2750 in April of 2013, culminating with the failed assault on the 140 handle this week. To confirm a reversal in the monthly trend, we will need to close lower than last month's low of 1.3673.
The recent strength in the euro has been baffling, as has been the strength of the European bond markets. Today, ten-year bonds yielded 2.95% in Italy, 2.91% in Spain and a mere 1.90% in France. With EU unemployment over 11%, and their growth barely positive, is this really an attractive place to invest your money?
It looks like Draghi has given us an answer to this question. It is better to have your money in the euro, and then invest appropriately, than to have your funds in Russian rubles. On Friday, it was reported in the Telegraph :
The European Central Bank says capital flight from Russia since the Ukraine crisis erupted may be four times higher than admitted by the Kremlin, a clear sign that sanctions pressure is inflicting serious damage on the Russian economy.
Mario Draghi, the ECB's president, said the outflows from Russia have been large enough over recent weeks to push up the euro exchange rate, complicating monetary policy for the ECB.
"We had very significant outflows that have been estimated by some to be in the order of €160bn out of Russia," he said, without specifying where the information came from.
The trade has been talking about a capital flight from Russian rubles to other currencies. Size of that movement was rumored to be $60B, but if the €160B number is right, this is $220B, approaching four times the original estimate. It now looks like Europe was and probably still is being flooded with repatriated money from their Russian business, loans and investments.
Europe is exceptionally vulnerable to the disruption of the energy flow from Russia or an increase in oil and gas prices. Since the outbreak of hostilities in the Ukraine, the euro strength was puzzling. But the sabers are still rattling and this means capital flight from Russia is not yet over.
There may be another reason to expect more money moving from Russia. To date, the drop in the euro has been only 9%, less than might be expected. If the modest sell-off in the ruble is because of CB intervention, the Russian economy has more troubles pending.
The Russian CB reports it has currency reserves of $477B. Buying the weak ruble may have stemmed the break, but this will compound the CB losses. In this process, they are giving up their hard currency reserves for the plunging ruble - not a good trade. Their currency reserves are certain to be falling, and are now less than reported. As cross border investors and bankers become aware of the size of the ruble run, the rush to flee the ruble zone will resume, and perhaps accelerate.
It is important to watch weekend developments in the Ukraine where the number of chaotic areas appear to be expanding. Some think that Putin wants control of the pipelines through the Ukraine which supply Europe with their energy needs. If true, the Ukrainian crises is far from over.
Longer term the turmoil in the Ukraine, with the potential for higher energy prices, should be bearish on the European economy and the euro. In the shorter term, the repatriation of EU investments from Russia will give us some buying in the euro despite the key reversal.
The euro buying during the past month were caused by forces still in play. Should the sell off continue next week, we wish to buy the EURUSD (FXE, UUP, UDN ) in the 1.37 area. There should be further support for this pair at around 1.3620 which is the approximate level of the 200 day SMA. Despite last week's action, a rally back to the 1.3850 level is possible.
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.