The Retreat: A 3 Month Outlook On EURUSD

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Includes: EUO, FXE, UDN, UUP
by: Cerebro1

Summary

The Euro is retreating against the U.S. Dollar.

This is being driven by the accommodative monetary policies of the ECB.

The Euro is expected to continue to decline against the U.S. Dollar over the next 3 months.

The Retreat: Three Month Outlook on EURUSD

A retreat, as simple as it sounds, encompasses many representations. Some types of retreats include the spiritual or corporate type retreat, where people group up to reflect and meditate on their core values, principles and beliefs. It is also used as a bonding experience. From the more common military perspective, armies retreat to escape danger and head to safety. Armies have also utilized the retreat as part of their military tactics, as far back as the general Sun Tzu, and even further. From a section of his Art of War, Sun Tzu illustrated, in his "Attack By" Strategy:

"It is the rule in war, if our forces are ten to the enemy's one, to surround him; if five to one, to attack him, if twice as numerous, to divide our army into two. If equally matched, we can offer battle, if slightly inferior in numbers, we can avoid the enemy, if quite unequal in every way we flee from him."

The retreat reflects a valid tactic. Turning to financial markets, prices also retreat from time to time. The Euro versus the U.S. Dollar, after making attempts to 1.40, formed a double top pattern and then proceeded to decline. From May 2014 it channeled downward, actually correcting a little over 11% move in 6 months. A death cross, which is a bearish sign, was also seen. It formed in early July 2014 where the 50 daily moving average fell below the 200 daily moving average. While recently there has been some positive divergence on the price momentum indicators, any move higher in EURUSD appears to be corrective. Given these technical conditionality as well as the accommodative policies of the ECB, EURUSD is expected to face a challenge if it attempts to return above 1.275. Thus it is expected that the Euro will retreat to 1.20 in 3 months' time. Investors considering to take advantage of this should consider the short Euro ETF (NYSEARCA:EUO).

Chart 1- EURUSD Daily Candlestick Chart

Source: Bloomberg

The ECB President Mario Draghi is attacking with full force against deflation. This year the ECB reduced its benchmark rate, the refi rate, by 10 bps to 0.05%, an all time low. This is seen in the chart below.

Chart 2- ECB Refi Rate

Source: Bloomberg

Also the ECB tackled deposit rates, surrendering it to negative territory, -0.15%. The central bank wants investors and firms to flee from the less risky short term fixed income instruments and take on business risk and other riskier investments, like equities. One view is the ECB's thinking that driving rates so low will stimulate growth and carry inflation rates higher, hence negating deflation. So far these actions prove minimal as the Eurozone's GDP flounder under 1% year-over-year and inflation, measured by CPI, is below 0.5%. The charts of GDP and inflation are seen below:

Chart 3- Eurozone GDP (year-over-year %)

Chart 4- Eurozone CPI (year-over-year %)

What is needed is a stronger army and cooperation. For both policies to work in this case monetary policy has to be accompanied by fiscal policies & reform, as seen by the UK and to a lesser extent the US' decisions post financial crisis. Nonetheless the policies currently being engaged in Europe purports Euro weakness relative to the U.S. dollar and as such a continuation to 1.20 is both possible & probable over the next 3 months.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.