It seems that the U.S. market has grown weary of worrying about the euro. The euro has lost 4.5% versus the U.S. dollar (EUR/USD)(FXE) since December 9, 2011 while the S&P 500 (SPY) has managed to gain 2.1% over that time. Moreover, the index is up 6.3% since its December lows. The euro is now trading against the U.S. dollar at levels last seen September, 2010. The S&P 500 is pushing against October highs and making a bid to finally erase all its losses from last August's swoon. The chart below shows that overall the S&P 500 has steadily out-performed the euro for several months.
click to enlarge
Ratio of the S&P 500 vs FXE
I sympathize with this apparent "euro fatigue" as financial markets enter a fourth year with the euro sovereign debt crisis weighing heavily in the air. Each stock market sell-off that has been attributed to euro woes has actually generated buying opportunities as financial markets cycle with the vicissitudes of European Union and ECB problem-solving. The charts show cycling through complacency, fear, panic, and relief with each phase of the crisis. Now, with U.S. economic data resisting expectations for an imminent recession, the market's relief is getting sticky.
I have earlier used the machinations of the euro as signals to refute or support moves in the S&P 500. Thus, the apparent decoupling requires that I adopt a different trading strategy. Even as I do so, I am mindful that trouble never matters until it does; I am bookmarking the euro's woes, not forgetting them. A January 6th article in the New York Times titled "Borrowing to Stay Afloat: Can Europe Pull It Off?" is one of many great reminders of the perils that remain.
To start accommodating euro fatigue, I executed two main strategic changes over the last two weeks.
I first closed out my standing short position in EUR/USD. This action locked in profits and now leaves me freer to fade rallies in the euro. Without positive news catalysts, I expect all bouts of euro fatigue that send the currency higher to be short-lived. Clearly, I would still be fine holding onto the original position as the (short-term) bottoming process I thought could be in process in late December did not materialize (the alternative scenario of further strength in the U.S. dollar and the Japanese yen did occur).
I am still holding my hedge against a sudden and surprise surge in the euro: EUR/JPY. I purchased euros against yen hoping to lace my hedge with the bonus potential of another currency intervention by the Japanese. With the euro now trading at 11-year lows against the yen, I will likely get stopped out of this position soon. If I am lucky, a relief rally consistent with euro fatigue will begin soon.
I next closed out the positioning for a devaluation in the Swiss franc. A month ago I laid out a strategy for playing the devaluation of the Swiss franc. I recommended the following:
The on-going and looming downside potential in the euro means that playing franc devaluation with EUR/CHF presents notable downside risks. Instead, going short the franc against other currencies may present a more palatable strategy.
While the Swiss have yet to implement any new devaluation measures since then, my recommended positioning performed even better than expected under the circumstances. The persistent decline in the euro did take a toll on the EUR/CHF currency pair, dropping it about 1.25%. Meanwhile, the U.S. dollar (USD/CHF)(FXF), the Australian dollar (AUD/CHF), and the British pound (GBP/CHF) all made notable gains against the franc. Without new Swiss interventions, these trades all reduced to shorts against the euro as the currency machinery spun mightily to maintain the EUR/CHF peg. These trades all turned out to be somewhat redundant to my negative bias against the euro.
The U.S. dollar continues to drift higher against the Swiss franc
I recently locked in final profits and closed out all positions in Swiss franc currency pairs (I held GBP/CHF the longest while I traded in and out of USD/CHF and AUD/CHF). Going forward, I want to maintain more flexibility. In particular, I want to be able to trade EUR/CHF to the upside if the Swiss National Bank (SNB) or the government telegraph imminent interventions. However, given the brewing scandal and controversy around the currency trading by the wife of SNB President Philipp Hildebrand, I am guessing such moves may occur even further out into the future. I imagine Hildebrand now faces substantial political risks from any interventions conducted before this controversy is cleared from the air.
In the meantime, I will trade dips in the non-euro Swiss franc currency pairs free of the need to make sure I am not caught over-weighted francs in a surprise intervention. The AUD/CHF remains my favorite franc currency pair, especially as the commodity currencies have proven relatively resistant in the last two weeks of the U.S. dollar's ascendancy. Note however that I continue to moderate my overall bullishness on the Australian dollar (AUD/USD)(FXA).
The dollar index continues to rise on the support of its 20-day moving average.
Source for last two charts: FreeStockCharts.com
Be careful out there!
Additional disclosure: I am also long USD/JPY, EUR/JPY, and AUD/USD.