EUR/USD: The Week Ahead

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 |  Includes: FXE, GLD, UDN, UUP
by: Vision Capital M.

The EUR/USD exchange rate continued to be under pressure during the last week, as we expected in the previous edition of our EUR/USD "week ahead" series. The euro lost another 1% against the U.S. dollar to end the week at $1.2851. The pair is close to touching the SMA200 on the daily graph at 1.2790 but still trades above it. The SMA served as a resistance point during one of the first sharp rises of the euro in September, so now it is expected to provide support. If this level breaks, the next support is around $1.2735 (the 38.2% Fibonacci retracement of the $1.2040 - $1.316 movement), as it can be seen in the daily graph below.

Click to enlarge

A declaration of Finance ministers of Germany, Finland and the Netherlands cited by Bloomberg, said the European Stability Mechanism that is expected to be approved on October 8, 2012 should not be used to buy legacy assets but bear responsibility for problems that occur only after the new European bank supervision framework is established. This generally concerns banks' problems that occur from 2013 onward.

Contradictions like this one weigh on the market expectations for a quicker resolution of the European debt problems and to some extent explain the current decline in the EUR/USD pair.

Another reason for the rise of the USD we witnessed the last week could be found in the economic data. The Q2 U.S. GDP unexpectedly declined to 1.3% on annual basis (from a preliminary Q2 value of 1.7% and a Q1 value of 2%). This, in combination with the U.S. durable goods decrease of 13.2%, caused the equities worldwide to decline on concerns of slowing U.S. growth. With Spain struggling with the decision to ask for a financial help and the recent weak economic data from Japan and China, the notion of increasing risk worldwide rose. This naturally leads to a risk-off environment in which currencies like the USD, Japanese yen of the Swiss franc usually gain support.

At the same time, the inflation in Europe rose unexpectedly to 2.7%. This supports the euro because the markets would expect a more restrictive monetary policy from the ECB.

Commitment of Traders

Commitments of Traders

The noncommercial futures traders continued to increase their long positions in the euro (a rise of 9.3%) but at a slower pace, according to the last commitments of traders report. The short positions declined faster (15.3% against the previous decline of 10.6%).

The bets on the rise of the euro continue to grow. Given that the current support levels hold, we could see another short covering which has the potential to cause a fast increase of the euro price in USD. The differences between the current values of long and short positions and their respective year-to-date and last 3-month averages continue to rise, as shown on the diagram below.

COT_long_short_ratios

The commercial futures traders continued to close their hedges against a possible euro price increase. They closed about 20T of long positions (15%), well below the 38% that were closed in the previous report. This could mean they do not expect the risk of a higher euro to materialize during their hedging horizon.

The Week Ahead

The current week includes several very important events concerning the EUR/USD rate - the ECB rate decision, the speech of the ECB President Draghi and the release of the FOMC minutes. Our expectations are that they will reaffirm the current central banks' views. The ECB could signal a further use of different tools in order to restore liquidity and lower yields in the Eurozone. A real buying of government bonds on the secondary market is one of the options available. All those could support the euro and give start to the next increase of its value relative to the U.S. dollar.

Investors who expect the euro to further appreciate against the USD could use a long position in the CurrencyShares Euro Trust (NYSEARCA:FXE). This ETF tracks the EUR/USD currency rate and has an expense ratio of 0.40%. A short position in the same ETF could be used by those who expect the euro to decrease in value against the U.S. dollar.

Investors who prefer to use more diversified options could use positions in the PowerShares DB USD Bull (NYSEARCA:UUP) ETF or in the PowerShares DB USD Bear ETF (NYSEARCA:UDN). Both funds are U.S. dollar denominated and track the value of the USD against a basket of six other major currencies. Their expense ratio is 0.50%.

Another, a bit more exotic option for those expecting the U.S. dollar to decline on a near- to long-term could be a long position in the SPDR Gold Trust (NYSEARCA:GLD) because of its general inverse movement to the USD value. As of the end of September 2012, the monthly correlation for the last one year between GLD and UUP is at -0.75. This could be used as a way of hedging a U.S. dollar exposure without engaging directly in the currency markets. This fund holds physical gold bullion and tracks the spot price of gold. It has an expense ratio of .40%.

Monday, Oct. 1

Event

GMT Time

EST Time

Consensus

Previous

EU Markit Manufacturing PMI (Sep)

7:58

2:58am

46.0

45.1

EU Unemployment Rate (Aug)

9:00

4:00am

11.4%

11.3%

USA Markit Manufacturing PMI

12:58

7:58am

51.5

51.5

USA ISM Manufacturing PMI

14:00

9:00am

49.8

49.6

USA Construction Spending (Aug)

14:00

9:00am

0.5%

-0.9%

Click to enlarge

The most important European event for the day is the release of the unemployment rate. Analysts surveyed Bloomberg in the article about the risk-off environment linked above, expect the unemployment to rise to the highest level compiled by the company since 1990. A negative surprise, i.e. a higher than expected value here would weight on the euro and a test of the $1.28 level could follow. Whether the market will be able to go down to the SMA support area would depend on the Markit manufacturing PMI value released earlier. A better than expected value could drive the euro higher.

The consensus for the construction spending and the ISM manufacturing PMI is for little to no change. A negative surprise is highly probable here having in mind the worse than expected data on the durable goods and U.S. GDP last week. This could weight on the USD and send the euro higher.

Tuesday, Oct. 2

Event

GMT Time

EST Time

Consensus

Previous

EU Producer Price Index (Aug)

9:00

4:00am

1.8%

USA Redbook

12:55

7:55am

2.0%

USA NAPM New York Index

13:45

8:45am

51.4

Click to enlarge

Tuesday is relatively calm concerning economic events.

The Europe Producer price index could show an increase given the higher commodity prices these days. This would support the euro due to expectations of a hawkish ECB policy although in a more long-term perspective, this could harm the Europe's economy as the growth could not be sufficient enough to offset the possible increase in consumer prices.

The U.S. Redbook would show if the noticed decrease in the U.S. consumption continues. This will give hints on the consumer sentiment. Any negative surprise here or in the NAPM New York index would weight on the U.S. dollar.

Wednesday, Oct. 3

Event

GMT Time

EST Time

Consensus

Previous

Germany Markit Services PMI

7:53

2:53am

48.3

EU Markit Services PMI

8:00

3:00am

46

47.2

EU Retail Sales (Aug)

9:00

4:00am

1.7%

USA ADP Employment Change

12:15

7:15am

146K

201K

USA ISM Non-Manufacturing PMI

14:00

9:00am

53.3

53.7

Click to enlarge

Wednesday starts with the Markit services PMI for Germany and Europe, which will show the sentiment of the service sector on the continent. It takes a big part of the GDP, but does not influence it as much as the manufacturing. Any positive surprise here or a reading above 50 would support the euro during the week.

The Europe's retail sales are expected to show no change or a slight decline compared to the previous reading. A positive surprise here would also support the euro.

The market expects a significant decline in the value of ADP employment change. Any positive surprise on this would support the U.S. dollar. The same is valid for the ISM non-manufacturing PMI.

Thursday, Oct. 4

Event

GMT Time

EST Time

Consensus

Previous

Spain 5-y Auction

N/A

N/A

6.456%

France 10-y Auction

N/A

N/A

2.21%

EU ECB Interest Rate Decision

11:45

6:45am

0.75%

0.75%

EU ECB President Draghi's Speech

12:30

7:30am

USA Initial Jobless Claims

12:30

7:30am

371K

359K

USA Factory Orders (Aug)

14:00

9:00am

-2.6%

2.8%

USA FOMC Minutes

18:00

13:00am

Click to enlarge

Thursday again seems like the most interesting day of the week.

Spain's and France's auctions could hint how the markets view the current economic conditions in Europe. The Spain one would be especially important given the increasing notion that the country will have to ask European Central Bank for support. If France's yield increases significantly, this could be a sign of a long-term problem in the country's ability to finance itself.

The ECB's rate decision has the potential to significantly affect the EUR/USD currency rate. Currently, the market expects that the Central bank will leave the rate untouched. Given the higher than expected reading of inflation in Europe released last week, a rate hike to 1.0% would not be so unreasonable. On the other hand, the M3 money supply showed a decline to 2.9% from a previous value of 3.6%. This means the inflationary pressures could be easing so a rate increase would not be necessary at the moment. Given however that such a surprising increase happens, this will be among the needed events that would drive the euro out of its current short-term downtrend.

The speech of Mr. Draghi is also important as it could signal further details about the tools the ECB intends to use in fighting the crisis and supporting growth.

On the other side of the ocean, the unemployment data and factory orders are expected to deteriorate further which would put pressure on the value of the U.S. dollar.

The FOMC minutes could also increase the volatility of the EUR/USD pair as they would reveal the actual debates in the committee concerning its economic policy. Market could gain hints on the arsenal available and its strength.

Friday, Oct. 5

Event

GMT Time

EST Time

Consensus

Previous

Germany Factory Orders (Aug)

10:00

5:00am

-4.5%

USA Average Hourly Earnings

12:30

7:30am

0.2%

0.0%

USA Nonfarm Payrolls

12:30

7:30am

116K

96K

USA Unemployment Rate

12:30

7:30am

8.2%

8.1%

USA Consumer Credit Change (Aug)

19:00

2:00pm

$8.0B

$-3.28B

Click to enlarge

Friday's significant events are again mostly concentrated in the U.S., with the exception of the Germany's factory orders. The previous value marked an increase while now the consensus is for a decrease. If factory orders decline, this would weight on the euro. Naturally any positive surprise would be supportive to the single currency.

The consensus for the U.S. hourly earnings is that they will grow slightly. This indicates a slightly elevated inflation pressure in the U.S. which would support the USD.

The consensus is that the nonfarm payrolls will rise. Given this happens not to be the case, such a surprise would generally weigh heavily on the USD. Its value however should be looked at conjunction with the unemployment rate which is released at the same time. A rise in the unemployment would in general mean the USD should deteriorate further, but given the Fed has almost used all of its tools to support growth and employment, such a rise could signal a need for a change in monetary policy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.