Why the ERO is Ready to Rally

The ETF that tracks the EURUSD exchange rate (ERO), has just bounced off its 52 week low of 51.60, and is currently trading at 54.75. From both a fundamental and technical perspective, it looks like the ERO could be preparing for a rally.

Below are three key pieces of evidence to suggest this may be the case:

1. The Fannie (FNM) / Freddie (FRE) bailout. The decision of the US government to bailout Fannie and Freddie is likely to have enormous consequences for the US dollar over the next few years. While the US dollar strengthened on the announcement (and thus the ERO fell), the fundamentals underlying the US dollar do not justify this; if anything, the dollar has weakened. The US government simply cannot afford this multi-trillion dollar bailout, and thus will need to expand the money supply via the Federal Reserve to pay for this bailout. The expansion of the money supply will invariably result in a devalued US dollar, and while the Eurozone is having its own economic problems, they pale in comparison to devaluation the US dollar is set to experience thanks to the bailout of Fannie and Freddie.

2. FDIC bailouts. Of course, Fannie and Freddie is not the only bailout in town. The FDIC has 117 banks on its watch list, up from 90 at the beginning of the year. The FDIC is already warning that it may need to borrow money from the US Treasury, as its current reserves are below the required amount of 1.15% of the total insured amount. This will likely lead to a need for additional money to be created via the Federal Reserve system, which in turn will further expand the money supply and devalue the US dollar.

3. Technically, a reversal is forming. Since the ERO was born under a year and a half ago, it can be useful to look at the actual EURUSD price action to get a longer-term perspective. The chart below is a monthly chart of the EURUSD for the past eight years. The market tested the strong support line at 1.3850, but promptly bounced off. As this strong trendline is still intact, the technicals suggest the long-term trend is still intact as well.

From a fundamental and technical perspective, the ERO seems ready to rally.

Disclosure: none

Comments

[dlaw:]

No, I'm sorry.

EUR/USD is taking a break here only in the sense that it is on a little upswing in the rollercoaster downwards. It was a bubble that popped and for the moment the traders' emotions are in control.

For those who trade this stuff (I don't), this would be a much better opportunity to put in a short or a short options play.

EUR/USD $1.30 is a mortal lock.

2008 Sep 14 04:06 AM

[elwind45:]

Without a US rate cut central banks will start selling dollars to defend currency rates. Korea is starting the process and many will follow lead. Has anyone noticed the large amount of world government failures? This episode ends with a falling dollar or a falling economy! I fear sunday night the bottom is blown out of world stock markets caused by IKE. I futher think this dollar rally is tied to export sales of softs. We do need to sell less softs so we have something left to consume!

2008 Sep 14 05:38 AM

[Matthew Car...:]

That is a valuable chart for one main reason: everyone is looking at the same thing.

I would say the Fed's statement this week is likely to be the immediate driver of the dollar, and I would look specifically at their wording regarding inflation.

In the last statement, inflation was a "significant concern," and I believe much will depend on whether "significant" is retained.

I also believe what was said in the minutes played a large part in the dollar's appreciation, and I'm referring to "although members generally anticipated that the next policy move would likely be a tightening..."

2008 Sep 14 09:07 AM

[NOWHEREMAN:]

LEH has failed, AIG may follow; MER is merging and the Treasury has suspended the Rule regarding the Sanctity of deposits by allowing Banks to use them.

The worst is yet to come. I expect the Fed to cut rates tomorrow to shore up the stock market. Probably 50 basis points. Why because the Fed has widened the Collateral acceptance to include Equities, a dropping stock market will ensure a drop in the amount which can be borrowed.

Good luck on your 1.30, you are going to need a lot...Just an opinion.

2008 Sep 15 05:06 AM