The same sentiment regarding quantitative easing being pursued into the perpetual future has overtaken the currency markets. While the euro has collapsed against many other currencies, it has shown remarkable resilience against the US dollar. The euro is only trading about 4% lower since peaking earlier this year, but we believe there could be significant downside as the currency markets come to the realization that US monetary policy is stabilizing and that the European situation is deteriorating.
While the political situation out of Europe has been quiet as of late, now that summer is over and politicians are returning, things could heat up again quickly. The dysfunction in Europe that we saw earlier in the summer has not gone away by a longshot, and is actually increasing. The usual suspects of Greece, Portugal and Ireland are no longer the only concerns, with the ECB recently being forced to buy Spanish and Italian bonds in the secondary market to support their prices.
The situation is an absolute mess, and there is still no actual solution to the problem. To make matters worse, the large economies of France and Germany are showing signs of slowing, with GDP increasing very slowly if at all. At some point, we expect the ECB to abandon their inflation-hawking agenda and actually decrease interest rates to spur growth, devalue the euro and increase exports.
On balance, we view the fundamental situation as bullish for the dollar, and market sentiment overly skewed against the dollar due to expectations of quantitative easing. Such a divergence between short-term trend and long-term fundamentals are exactly the type of situation we seek to profit from.
Due to recent volatility and the ability of the current dollar-negative sentiment to persist, we recommend shorting the euro on a trade below the 1.40 level. While prices have been moving in quite a tight channel for some time, if the euro breaks significantly below 1.40, the catalyst necessary for traders to start sustained selling of the euro and buying of the dollar could commence.
Disclosure: I am short euro futures
Disclaimer: All information included herein is the opinion of the firm and should not be considered investment advice. Past performance is not necessarily indicative of future results.