EUR/USD Could Decline Short-Term

Includes: FXE, UDN, UUP
by: Angelo Airaghi

The power struggle continues in Washington D.C., while economic conditions are fragile and risk stays high. Athens was torched on Sunday. The ECB could cut rates in March or April, if the new Greece's bailout will not reassure the financial markets. A weaker euro would beneficial for Europe. However, any decline should be temporary for now.

U.S.: Exports have declined slightly.

The heat remains high in Washington D.C. The Bush tax cut will expire January 1, 2013. Dividend, income and capital tax rates will rise, if an agreement is not found. Republicans are saying tax increase will slow growth, limiting the net effect on the deficit. According to the Congressional Budget Office (CBO), tax revenues will instead rise more than 30% between 2012 and 2014. During the same period, the deficit would be reduced by 68%. At the contrary, the public debt would reach 94% of the G.D.P. in 10 years, according to the CBO, if the Congress votes to extend provisions. Who is right? For sure, the fiscal burden will be heavy in 2013.

Growth stays fragile. The contraction of world economies could limit investment, production and employment. Imports have gained momentum in the last quarter of 2011, while exports have slightly softened. A decline was in the cards. Since 2009, exports have almost doubled the rate of growth registered in the last forty years. They should remain the driving force behind the GDP, considering the U.S. dollar is competitive against the majors and wages are low. Latest data showed the manufacturing employment diffusion index reached 69.1 in January. It is the second monthly reading in history. In reality, the labor market is overall soft. The latest decline in the unemployment rate is also related to a weak labor force growth.

Greece saved again. Or was it not?

As protesters were torching Athens, the Greek parliament passed a new austerity bill that will secure Greece a new bailout fund of euro 130 billion. Will it be enough to reassure the financial market? Time will tell. However, it will give more time to better prepare all parties involved for the possible bang. Public sector creditors are removing private sector's exposure to Greece to the PSI (Private Sector Involvement). The European Central Bank is trying to find enough capital to protect those nations exposed to the Greek's debt.

Another three-year LTRO will be introduced at the end of February. More banks could participate, since the number of collaterals used to gain liquidity has been increased. The E.C.B. is adopting a "wait-and-see" approach on rates. In March/April, they could be cut again by 25/50 basis points, if the debt crisis will deteriorate

A weaker euro would be good for Europe.

Greece does not have any more room for improvement. The economy is contracting for the fourth consecutive year and the population is fed-up with the measures. Clearly, austerity is not enough. Why? Fiscal revenues drop and more austerity is needed, which contracts demand. Growth must pick up to end the vicious cycle. Exports would help, but the currency must fall. European rates should be lower than American rates. It will eventually occur. For now, the longer-term cycle stays bullish for EUR/USD.

Over the short-term, nonetheless, risk aversion could support the dollar. EUR/USD might correct to 1.2980, 1.2850 and eventually 1.26. Technically, the price is leaning against both the upper channel-line and the 100 days moving average. Finally, there is a strong divergence between current price and the RSI indicator on the daily/weekly chart. In the past, it has been a strong indicator of trend's reversal.

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