During the previous week, the euro bounced back against the U.S. dollar after getting close to the SMA200 on the daily graph, as expected in the previous edition of our EUR/USD "week ahead" review. The single currency marked five consecutive days of gains during the week to finish at $1.3028 on Friday. The appreciation of the euro against the USD for the week equals 1.7%.
We would not be surprised if the advance of the euro decelerates during the current week or even if the currency finishes the week lower. Reasons could vary from profit taking to doubts about the outcomes from the many political meetings and officials' consultations that are expected to take place around the world.
The Week of Political Risk
On Monday, Oct. 8, the finance ministers of the 17 countries which are members of the Euro area will meet in Luxembourg to discuss the Spain's situation. They are also expected to approve the European Stability Mechanism, the permanent EU bailout fund, which was set to be operational during the current month. The European bank supervision framework would also be an important topic on the meeting's agenda. The outcomes of these discussions could set the long-term road in front of the euro by further easing the financing conditions for the European banking and financial system. This facilitation includes an increased ability to affect sovereign yields in the eurozone by adding the ESM's buying of sovereign bonds to the ECB's one. Another euro positive factor will be the ability to provide a direct financing to troubled banks throughout the eurozone. All those, if approved by the financial ministers, will clear some of the biggest hurdles before the single currency's appreciation.
On Tuesday, Oct. 9, the meeting in Luxembourg will be expanded to include financial ministers from all the 27 members of the European Union. On the same day, the German Chancellor Merkel will visit Greece as a sign of her support for the country's staying in the eurozone.
On Wednesday, Oct. 10, the Spanish Prime Minister Rajoy will meet the French President Hollande in talks about the Spain's overhaul efforts. Spain currently is the main source of risk for the eurozone. Even if the country files a bailout request soon, the civil unrest against the needed austerity measures could cloud the market expectations for an easy resolution.
On Thursday, Oct. 11, the meeting of the G7 group will be held in Tokyo. According to a Reuters article, the European ministers who attend the G7 meeting will "point a finger at Washington as a potential source of economic stress." The article states that:
"In particular, the U.S. needs to agree by the end of the year on how to deal with the 'fiscal cliff' and, at the same time, adopt a credible fiscal consolidation plan."
On Friday, Oct. 12, starts the annual International Monetary Fund meeting. It will be held during the weekend in Tokyo. The expectations are that Greece will be among the main topics as the IMF continues to insist that the European governments restructure the Greek debt they hold.
With so many political events concentrated in one week, we should expect the volatility of the EUR/USD pair to rise given the uncertainty of the outcomes. This could lead to sizable movements of the exchange rate in both directions. However, given that no significant change in the officials' intentions is expected to happen, the major uptrend of the EUR/USD rate could remain unbroken. At the end of the week, the important determinants of the exchange rate should still be the economic data, expectations and technical factors like supply and demand for the respective currencies.
The Week Ahead
Investors who prefer to take advantage of changes only in the EUR/USD exchange rate could utilize a position in the CurrencyShares Euro Trust (NYSEARCA:FXE). This ETF tracks the euro currency rate measured in U.S. dollars. It has an expense ratio of 0.40%. Depending on one's expectations of the exchange rate movement a long or a short position could be used.
PowerShares DB USD Bull (NYSEARCA:UUP) ETF or the PowerShares DB USD Bear ETF (NYSEARCA:UDN) are an option for the investors who prefer to track the value of the USD against more currencies. Both funds are U.S. dollar denominated and track the value of the USD against a basket of six other major currencies - euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. The funds' expense ratio is 0.50%.
A bit more exotic option that was first mentioned in the previous edition of our weekly review, is taking a look at the SPDR Gold Trust (NYSEARCA:GLD). Those expecting the U.S. dollar to decline in a near- to long-term horizon could use a long position in the ETF 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%.
The correlation between the USD, or UUP in this particular case, and GLD should be periodically evaluated because a change to a lower value is possible. Any such change would lower the effectiveness of the hedge and further actions from the investors might be needed.
Monday, Oct. 8
Germany Trade Balance (Aug)
Germany Exports, m-o-m (Aug)
EU Sentix Investor Confidence (Oct)
Germany Industrial Production (Aug)
Monday is a day-off in the U.S. so the major economic data come from Europe. It mostly concerns Germany which is among the main driving forces behind the EU economy. A better than expected reports on the data could drive the euro up against the U.S. dollar.
The Sentix investor confidence index shows the financial analysts and institutional investors' assessment of the current situation in Europe and their expectations about the next six months. The consensus is that it will show a slightly better reading than the previous one. A positive surprise here could lead to appreciation of the euro.
Update as of Monday, 9:00am GMT: The Germany trade balance and exports showed better than expected values of €18.3B and 2.4%, respectively. The Sentix investor confidence however did not justified the consensus and although the reported value (-22.2) is slightly above the previous reading, it is significantly below the expectations. After the Germany data releases, the euro initially rose back to $1.2990 but later it continued its decline to the $1.2960/70 area.
Tuesday, Oct. 9
France Trade Balance (Aug)
USA NFIB Small Business Optimism Index (Sept.)
USA IBD/TIPP Economic Optimism Index (Oct)
There is not much economic data concerning the EUR/USD pair on Tuesday, too.
France trade balance could have some positive impact on the euro exchange rate against the U.S. dollar if the data show a significant improvement.
On the other side of the ocean, the small business optimism index will show what are the expectations of business owners concerning the economic situation in the U.S. The IBD/TIPP index will show the consumer sentiment. A positive surprise on both indicators could support the USD.
Wednesday, Oct. 10
Germany 30-y Bond Auction
USA Mortgage Applications (Oct 5)
USA Wholesale Inventories (Aug)
USA 10-y Note Action
USA Fed's Beige Book
Europe's economic event for Wednesday is the German 30-y bond auction. A higher than the previous yield could show an increase in the risk appetite of investors which would be supportive to the euro.
The change in the mortgage applications in the U.S. will show the direction of the housing market in the country. Generally a decline should weight on the U.S. dollar as it would mean the housing recovery is questioned. As the USD happens to be perceived as a safe currency in troubled times, however, a combination of a slowing housing market and some signs of trouble from other parts of the world could lead to an USD appreciation.
The U.S. 10-y note auction will show the fixed income market participant's attitude towards the recently announced QE3. After the initial rise of the yields in the long end of the yield curve which sparkled some low risk bond investing strategies that seek to profit from a steeper yield curve, the yields have gone down again. Any increase of the yield might signal a returning of the risk-on environment and elevated inflation expectations. Those would weight on the value of the U.S. dollar against the euro.
The release of Fed's Beige book is important because the book would reveal how businesses, analysts and economists from the 12 Federal Reserve Districts view the U.S. economy. An optimistic view could strengthen the USD.
Thursday, Oct. 11
Germany Consumer Price Index
EU ECB Monthly Report
USA Trade Balance (Aug)
USA Initial Jobless Claims
USA 30-y Bond Auction
USA Monthly Budget Statement
Thursday starts with the CPI data for Germany. The consensus expectation is for a slight decrease. Any surprising value above the consensus could drive the euro value higher because of renewed expectations of a tighter ECB monetary policy.
After leaving the interest rate unchanged last week, the event that could further share light on the ECB's expected policy is the bank's monthly report.
The U.S. trade balance is expected to show an increased deficit despite the relatively lower USD during August. Any surprising decrease of the deficit would support the U.S. dollar.
After the last week's surprising decline of the U.S. unemployment to 7.8%, the jobless claims are to be watched with interest. The consensus expectation is for a rise of the initial ones to 370K. A lower value than this would support the USD.
The considerations about to 10-y notes explained above are also valid for the 30-y bond auction on Thursday. An increase in the yield would mean a change in the current inflow of money into Treasuries and a possible shift in the risk taking sentiment.
The monthly budget statement of Financial Management Service has implications about the possibility of the U.S. facing the "fiscal cliff" during the current year. An unexpected increase of the budget balance would significantly weight on the USD.
Friday, Oct. 12
EU Industrial Production (Aug)
USA Producer Price Index
USA Producer Price Index ex. Food & Energy
USA Reuters/Michigan Consumer Sentiment Index (Oct)
Friday's events are again mostly concentrated in the U.S., with the exception of the EU industrial production. Market expects that the tendency of a declining industrial production, which till now is present during most of the 2012, will continue. This is expected to be the biggest decrease for the year-to-date and as such it could weight on the euro's ability to sustain its appreciation.
Due to lower food and energy prices, the U.S. producer price index is expected to show a decline compared to its previous reading. Generally any surprise from the consensus would drive the U.S. dollar value in the direction of the surprise. However, with the Fed's current aggressive commitment to monetary easing policy with no end time defined, higher inflationary expectations could only support other asset classes appreciation and further decrease the U.S. dollar value.
A reading higher than the market consensus for the Reuters/Michigan consumer sentiment index would show the consumers as being more confident in the U.S. economy. This would support the USD.
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.