If you have followed my posts on the euro in the past on my website, you would know I am not the biggest fan of European Union’s common currency. Yesterday, the ECB announced that it will raise its benchmark interest rate 25 basis points from 1% to 1.25%, becoming the first developed nation to take a step away from easy money policies and toughening its stance on price stability. The news came following an official request from Portugal for an EU bailout after the country saw its 10 year yield rise over 100 basis points over the last month.
As we can see, the euro has been on a significant uptrend following the initial expectation for higher rates earlier this year. The currency once again is facing a resistance level that it is failed to break during the past few attempts. This is an optimal opportunity to short the currency as I feel it has had too big of a run up for a marginal rate hike while ignoring all the fundamental flaws with the currency.
The key issue that will ultimately have a material effect on the value of the euro is if there will be further hikes in interest rates from the ECB. Jean-Claude Trichet, the president of the European Central Bank, stated in a press release following the announcement of the rate hike that further rate hikes are inevitable but not imminent. This should give some relief to the rapid rise of the currency, as Trichet basically said that this won’t be one of many steps as the markets were expecting.
Also, Portugal once again brings the spot light under the sovereign debt crisis in the euro zone, after much media attention was diverted away by Japan and the Middle East. Portugal will officially become the third country out of the 17 nation currency bloc to receive a bailout, adding further fear to investors already wary of the stability of the uni. Clearly the capital markets had no faith in Portugal’s survival.
In the above chart, we can see why Portugal was forced to request a bailout.
As countries begin to fall in a domino effect, it once again brings to question the efficiency of a common currency. And each time this question has been brought up in the past 15 months, markets have tended to lose faith in the currency following the preceding rapid rise. When problems began spurring in Greece towards the end of 2009, the euro fell from 1.51 to 1.18, just to rise back up again to 1.42 on easing concern of the debt crisis. But once Ireland came into the picture, the Euro fell below 1.30, but again just to rise back up to the current level of 1.43. We can clearly see the pattern here. As one country gets bailed out, the markets begin focusing on other issues just to return to the fundamental problems underlying the currency.
Another thing to be cognizant of as we approach the summer months is a hike in the Fed Funds Rate. Without a doubt, even a minimal rise in the interest rate will strengthen the dollar a little bit and calm inflationary fear in the U.S. markets. Therefore, the dollar should strengthen against the euro in the short term.
Non currency traders can short the euro through the ETF EUO. EUO is a ProShares Ultrashort Euro fund, looking to replicate the daily movements of the Euro. Be aware though, EUO is a leveraged fund, looking to return 2x the daily movements.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in EUO over the next 72 hours.