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Is there anyone who does not know the Europeans have a severe debt crises, which has the potential to engulf the world in one more financial meltdown? The weeks fly by, but the news and the fears of a Greek exodus from the euro, and the risk of contagion spreading to other counties, remains the central theme of financial markets.

Free markets, supposedly efficient, are expected to discount the future. By now you would think even the financial back waters would be aware of the plight. The question arises then, how much of the European mess has been anticipated by the market? Usually markets discount future development but once. Are there still potential revelations that will surprise the markets?

The euro has been at the epicenter of the potential crises. Anticipated is a default by Greece and a messy exit from the euro, leaving behind billions of bank debt, and leaving Greece with insufficient funds to provide basic services. As the fears mounted, the traders in the euro increased as shorts extended their positions.

In the futures market, the open interest in the euro was about 282K contracts on May 1st. By the end of trading on the 15th, the OI had increased to 357K. The EUR/USD high on May 1 was 1.3283, and that pair proceeded to fall to a low of 1.2666 today. Since the OI has been going up in a down market, this tells us the specs have been adding to their short position. The last COT report showed specs short 183,685 contracts.

This has taken the 14 day Relative Strength Index (RSI) down to 21. A level of 30 is usually considered oversold. Sometimes there are cases when markets stay in oversold conditions for a lengthy period, but this is unusual. For this low RSI to continue the market will need daily doses of bear news. Failing to receive continued bear news, this market, with lots of new U.S. dollar longs, may get very nervous. A short covering rally will occur at some time.

There are some other pairs that have been slammed by fears of a global economic slow down too. The NZD/JPY has been down hard from 65.42 at the beginning of the month to a low of 60.57 today. Like the euro the NZD versus the yen is well oversold. Basis the RSI, the NZD/JPY is down to 18.30, and against the USD, the RSI is about 21.

The Swiss franc versus the USD is another interesting situation. On the first of May the USDCHF traded at a low of 90.42. The USD has since rallied to a high of 94.81 today. At the current level of .9451, the RSI is 78.68, well above the overbought level of 70. With the continued intervention by the Swiss National Bank, the SF is pegged to the euro by the SNB at 1.20. As the euro sells off, the SNB must sell the SF and buy the euro to keep the spread at 1.20.

Looking at the last COT report speculators were short 26,734 contracts of the franc, trying to mimic the SNB and the euro. During the May sell off in the euro, the OI in the SF futures has climbed smartly, from 41K at the month's beginning to 64K at the close yesterday. Specs have added to their short SF aggressively, and are short over 90% of the enlarged SF futures market. When the euro turns for a rally, the composition of the SF tells us the USD might have a sharp break versus the CHF.

These are fast markets and loaded with speculative players. As always the timing is critical in markets but markets do go to far and then reverse. We suspect the NZD has been sold too heavily as has the SF versus the USD. For the euro versus the USD, there are lots of new USD longs that might be quick to exit the markets should a change in sentiment develop.

Click to enlarge charts

Source: How Much Of The European Malaise Is In The Currency Markets?