If Germany Leaves, It's Lights Out For The Euro

 |  Includes: EU, FXE
by: Simit Patel

I haven't traded the Euro much over the last few years -- I've been of the perspective that there are much better opportunities -- though I've maintained a viewpoint that the Euro would appreciate relative to the US dollar on a multi-year basis. I've changed my mind over the past few months in this regard, however, due largely to the following:

1. Technically, a pattern of lower highs is in place; EURUSD reached an all-time high of beyond 1.61 in 2008, but could not get past 1.52 in 2009 or 1.49 in 2011; as such, I think the bear is now firmly in place, and more bears will pile on on rallies -- thus setting the stage for new lows to be reached.

2. The ECB did raise interest rates this past spring, a move that was widely anticipated. I suspected this would attract capital seeking yield, although instead the opposite has occurred; capital fled due to the debt and deficit spending problem that higher rates reveal. This has also magnified the need for greater fiscal unity, and a greater relinquishment of national sovereignty of European nations to a supranational government for the entire Eurozone, if the Euro is to be maintained.

However, the real event to watch is that of Germany, and whether it will remain a part of the Euro. Like many who have believed that the Euro's problems were far greater than the US dollar's, I maintained this view largely because I regarded the German economy as being of sufficient strength (in spite of its growing debt and deficit problem) to compensate for the multitude of crises facing the Eurozone. If Germany pulls out of the Eurozone, this rationale is lost.

And so, I've started to enter a few short positions in the Euro over the past few days, and will look to add more if the Euro/US dollar exchange rate can rally to 1.35.

Ultimately I still regard the Eurozone as having more economic confidence than the US -- although I think it is going to take some strong central bank action to bring this out. Once QE3 is announced in the US, and once China proves that it is more interested in supporting the Euro than the US dollar (which may come to fruition if military tensions between US/Israel and Iran escalate), than I think a higher Euro/US dollar exchange rate may be in the cards.

However, these actions could be fairly far off, and as for now, I believe fundamental factors such as a lack of QE3 in the US and Germany's growing desire to leave the EU, coupled with technical factors such as the emergence of lower highs on rallies in Euro/US dollar exchange rate since 2008, make a strong case for bearishness at the time being.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.