Euro: This Isn't A Bottom

Includes: FXE
by: Kathy Lien

The euro enjoyed its strongest one-day rally against the U.S. dollar since the beginning of July. While we would love to see the EUR/USD bottom because that would mean the end of all this uncertainty and volatility, today's recovery is nothing more than a relief rally. The rebound was triggered by comments from ECB member Nowotny who argued the merits of giving a banking license to the European Stability Mechanism. The mere hope that additional crisis management solutions are being discussed by European policymakers helped to stem the losses in the euro. However let's be clear, a license has not been announced and in fact Germany's Constitutional Court has not even approved the ESM.

Economic data out of the Eurozone continues to surprise the downside with German business confidence falling to its lowest level in more than 2 years. Independent rating agency Egan Jones also cut their rating of Italy's sovereign debt to CCC+ from B+, which puts the country deeper into junk status. While the impact on the euro was nominal because Italy is still rated as Baa2 by Moody's and BBB+ by S&P, Egan Jones' decision reflects the growing risk of holding euros. With Spanish bond yields at a level that is unsustainable over a long period of time, unless we see a permanent decline in yields, the Eurozone sovereign debt crisis is far from over and for this reason, the EURUSD recovery is nothing more than a relief rally.

Yet it is still important to mention that Spanish 10 year bond yields fell for the first time in 10 trading days. Given how the EUR/USD has been deeply oversold, today's recovery certainly reflects some degree of short covering. Spanish and Italian stocks also rebounded after dropping more than 10% since the beginning of the month. While we believe that the ECB will eventually come to the aid of the Europe, giving the ESM a banking license may not be their first option. Earlier this month, ECB President Draghi said "I don't think there is anything to gain by asking the institution to act outside the limits of its mandate, thereby destroying its credibility" when asked about allowing the ESM to use the ECB. Nowotny admitted that he is not aware of any specific discussions about this possibility within the ECB at this point. In other words, Nowotny is only sharing his own views. Additionally, the ESM can't come into effect until the German Constitutional Court approves it, which won't be until mid September at the earliest - another reason why we believe the support the EUR/USD should be fleeting.

German consumer confidence and import prices are the only Eurozone economic releases on the calendar tomorrow. Italy will be holding a bond auction and strong demand will help the euro while weak demand will hurt it. The Spanish Finance Minister will also be testifying in Parliament on the bank bailout.

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