In the past, I’ve referred to the Euro Zone as a tale of two countries. Rich Northern members led by Germany and France, and of course the impoverished PIIGS. This analogy has been more apparent in the last week than ever before.
Friday, Jean-Claude Trichet green lighted a bump in interest rates by the ECB of 25 base points from 1.00 to 1.25 percent. Why? - The fear of growing inflation. This is an understandable decision under normal circumstances for a central bank, but not when multiple Euro Zone members are still battling sovereign debt issues of epic proportions. I’m not a zealot – George Soros agrees as well.
There is simply far too much bad debt on the books for the ECB to be charting this course and at this hasty a speed. Higher interest rates will dampen access to cheap capital, which has been a boost to struggling European banks during the financial crisis. This fact alone will make the recovery efforts of the PIIGS that much more difficult. Trichet is acting like the Euro Zone is healed. But we still have two separate economies, and the rate hikes will more than likely worsen the woes of the Continent.
To my detractors, I would point to Trichet’s reluctance to even discuss the implications of the rate hike. Also, there is growing speculation that the ECB strong-armed Portugal by making them banks cut down on lending. This made me seriously question about the capabilities of European leadership. That, plus the technical topside resistance in the mid $1.40s is why I am bearish on the Euro.
Here is the play that I’ve been watching as I anticipate a correction in the Euro. Check out the Ultra Short Euro ProShares ETF (EUO) track record over the past year – perfect inverse correlation and a good choice.
Other potential plays to short the Euro that I found using our macro-trend screener – Gladstone Investment Corp (GAIN) and Energy Partners Ltd (EPL). The kicker to my pessimism on the Euro – With the end of QE2 on the horizon, I expect a resurgence story for the US Dollar. Welcome back old boy!