EUR Short Squeeze Is A Friend

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Includes: AUNZ, FXA, FXB, FXC, FXE, FXF, FXY, UDN, UUP
by: Dean Popplewell

By Dean Popplewell

The Draghi effect is trying to wear off. The market is saying to policy makers to “put money where your mouth is or we are not playing the upbeat card.” Yesterday, it was “risk” that got all the support after Draghi said that the ECB was ready to do “whatever it takes to preserve the EUR.” This morning, fading hope is preparing itself to tune into U.S. GDP data. Considering recent weaker U.S. data, investors are still wondering on how to lay their bets on whether the Fed will embark on another round of QE. A soft GDP print this morning will cause the betting to quickly intensify that something may be afoot at next weeks FOMC meet. A weaker growth reading would most likely be negative for risk appetite overall.

Draghi’s comments were made against a backdrop of climbing Spanish bond yields. This week they topped +7.7%, again stoking fears that the negotiated bank bailout would probably not be enough to stabilize the ailing Spanish economy. However, periphery yields have continued their fall today sparked by Draghi’s pledge. Despite this-50bp reprieve, borrowing costs for FI dealers periphery bully victims is still too high to be sustainable in the long term. Technically they require another couple of hundred basis point drop to remain solvent longer term. Most of Draghi’s comments were not new, it was his comments on the bank’s mandate that has caused yields to ease. He hinted that the bank might reactivate its bond buying program for financially stressed euro-zone countries. So any rumors or any rhetoric hinting at bond buying will support the EUR market.

Activity measurement compiled by the CEPR and the BoI reveals nothing that the market was aware of beforehand. The pace of the euro-zones economic contraction picked up this month as consumer and business confidence weakened in the face of deepening fiscal and banking crisis. Their Eurocoin indicator fell to -0.24% from -0.17% in June. The indicator is intended to estimate q/q growth in GDP, excluding erratic components such as seasonal variations. The July Eurocoin reading indicates that contraction deepened at the start of the third quarter, setting the EZ on its course for recession. This indicator is one of the earliest measures of economic output in the region and is consistent with regional services and manufacturing PMI’s. They all point to slower growth or contraction for the remainder of the year.

July 27

And we thought it was going to be quiet session ahead of GDP. Again the EUR is relying on headline trading to prevent it from a grander assault on key support levels. The single unit has whipped itself around from BUBA headlines and dragged itself off the lows on EFSF bond buying suggestion. It seems that investors are in the buying dip mode. The market is historically short and disposed to preserve profits ahead of next week’s key events. The longer term trend remains a friend of these short positions. What seems to be occurring is the market calling out the ECB’s ability to meet their words with action. Dealers continues to see macro fund selling interest close to the figure (1.23), however the technical overall scope is for gains to 1.2395. Close to this point would be the 50% retracement of the 1.2748-1.2042 leg. Pockets of support are beginning to form ahead of last weeks low and as high as 1.2245-50 again. It looks as if investors are recommended to play the EUR short squeeze as the currency is oversold “across the board.” Expectations for the ECB to take steps to stabilize could spur further short covering in the single currency for most of today.

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