FXE: An Excellent Addition To Your Portfolio, No Matter Which Way The Wind Blows

| About: CurrencyShares Euro (FXE)

Summary

The Eurozone's bleak outlook combined with rosy forecasts in the U.S. has put downward pressure on the single currency.

A healthy dose of QE is built into the currency's current price.

The current level seems to be based on the Federal Reserve becoming the Bundesbank and vice versa.

Expect to see less monetary intervention in the Eurozone and a longer wait for an increase in interest rates in the U.S. than the market is anticipating.

The euro currency at its current price offers value regardless of the direction of global equity markets.

My interest in the euro currency perks up whenever I see it trading near the $1.20 level; an area it has bounced off of for the past 10 years. So when I saw it fall through $1.23 back on December 5th, I did a quick search to see what folks in the investment community were thinking. To my surprise, I could not find a single article bullish on the currency.

After examining the most prevalent arguments for an even lower valuation, I believe that the bearish story has holes and places far too much faith in the European Central Bank and Federal Reserve. Investors shorting the euro at this level may find themselves surprised at the single currency's resilience as I expect it to trade flat-to-up through 2015.

Is It The Chicken Or The Egg Or Something Completely Different

One of the most intimidating aspects of investing in the foreign exchange market is, for lack of better words, trying to understand what it is you are supposed to understand. Visit any forex website and you will find no shortage of charts with funny symbols and arrows, along with discussions of current account balances and carry trades; enough unfamiliar lingo to send you on your way as quickly as you arrived.

Another issue is that there are often different forces simultaneously working against each other, with the prevailing variable ultimately leading to a currency's valuation. But I feel we are entering a period where we can ignore a lot of the inputs and just focus on a more crude, back-of-the-envelope type of methodology when thinking of what currency to own.

Forget for a second interest rates, inflation, real and nominal spreads, purchasing power parity, and the like. Instead, simply ask yourself, if we were in a risk-on environment, which currency would the assets that I want to own be denominated in?

Conversely, if you thought the equity markets were about to tank, where would you flee?

Now, some of the items I dismissed may play a role in your decision making process. But in this environment of either reaching for the stars or preparing for Armageddon, I think they play a secondary role. It is in this light that I believe the euro near $1.20 is strategically positioned for either environment and that all of the risk is to the upside.

Unstoppable Forces

The euro dropped sharply this past Wednesday after the Federal Reserve shifted a few words in its policy statement. According to the Fed, it will now be "patient" when considering how long to wait before raising interest rates. Previously, it used the words "considerable time," in describing how "patient" it would be.

And with that, an equity rally was launched; risk was back on the table and stocks across the globe raced higher.

In currency land, the PowerShares DB USD Bull ETF (NYSEARCA:UUP) rose 1.24% on the day of the Fed announcement and continued moving higher for the remainder of the week, ultimately adding 1.97% subsequent to Chairwomen Janet Yellen's speech.

Conversely, the CurrencyShares Euro Trust ETF (NYSEARCA:FXE) fell through its 52-week low, losing -2.31% after the Fed's final policy statement for 2014.

The weakness of the euro would seem to be the product of higher expected interest rates in the U.S. and the belief that some form of QE is all but certain in the Eurozone. With this, it would seem obvious that more pain is in store for the single currency. But that is only if you believe two things:

  1. The Fed will raise rates in the time frame it has indicated.
  2. ECB President Mario Draghi gets his way and launches an aggressive QE program.

Now, both of these things may very well happen, but my feeling is that we will see neutered versions of both.

For one, the Fed's timeline is based on economic indicators that, for me, seem shaky at best. I am not saying that manipulation is involved, but rather, I am not sure if things are as rosy as the numbers indicate. Historically, my "Midwest" model has been a bit more accurate in assessing the broader economy.

This model is quite simple; I head back home and ask friends, family, and pub patrons how things are going. What I can say is that people are definitely more upbeat now than recent years. However, very few are boasting of making more money than they were before; actually, most are just happy to be working again even though they may be making less or receiving fewer benefits.

The point is, this market recovery has included record consumer borrowing from individuals earning less income. The fact that inflation has been low has masked what could be a massive problem should it seep into non-discretionary consumer spending budgets.

Ultimately, you cannot expect sustained growth on the back on perpetual falling costs, increased borrowing, and flat wages. I would suspect that the Fed will be very patient in determining when to raise rates.

On the flip side, The ECB has shown a penchant to consistently do less than expected. Much of this has to do with the resistance of Germany.

Indeed, even during the worst of times, the Deutsche Bundesbank has rejected the idea of the ECB intervening. German ECB board members have even referred to the idea of QE as central bankers, "acting like fairy godmothers, creating value out of thin air."

The opposition of Germany and other like-minds already has the ECB trying to find a form of QE palatable for everyone involved. In the end, it will most likely have to involve weaker Eurozone countries absorbing more of the risk and cost of any program initiated, thus limiting its overall size and, at minimum, being less than investors are hoping for.

But let's say the ECB does unleash a sizable QE program. Initially, this easy money environment will put downward pressure on the currency. But, just like with the dollar and QE, once equities begin to look more and more attractive, the euro will be supported by capital inflows and eventually drift upward and through today's level.

In the end, in this risk-on environment, I believe too much pessimism is already built into the euro currency and that we are very near the bottom.

Immovable Objects

As the Architect said in the movie The Matrix Reloaded, "the problem is choice." This problem isn't due to having too many choices but rather too few. In this period of extreme volatility, deciding where to move your money in a risk-off environment becomes quite easy based on the limited viable options. At the end of the day, if investors can own only two assets, they will more or less flock to Bunds and Treasuries.

That is not to say that there aren't any other options. But when the central bank of one of the most viable possibilities is so fearful of a rising currency that it has imposed negative interest rates, and the remainders are export-driven economies, it is best to stick with countries that are tried and true.

In this climate, I like the euro even more than the greenback as I believe investors currently own more dollars than they care to and would look to diversify some of that risk away. At the end of the day, among the few legitimate options available I think the euro sitting at its 52-week low offers the best risk/reward scenario.

Also, while it does not make a trend, since October, the euro has moved inversely to the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) and I believe this pattern will continue to play out should we see the markets begin to fall.

Conclusion

I believe the euro is trading at a level that offers value in both a risk-on or risk-off environment.

If you think the equity market is due for a correction, it is my opinion that the euro offers the most upside of all currencies as it is oversold due to its current unattractiveness in a risk-on marketplace, and is backstopped by Germany and, to a lesser degree, other Eurozone nations boasting solid credit ratings.

Moreover, even with an ample QE program, I see a scenario where Eurozone assets become enticing and attract enough capital inflows to eventually reverse the currency's downward trend and push it higher.

If you expect global equities to continue their upward trend, I still like FXE between $120-$121 as I believe the risk is to the upside, but I would also sell the 30-day calls against the position to earn income and take advantage of what may possibly be a range-bound investment for a period of time.

Either way, I would be a buyer of the euro ETF as it provides a solid risk/reward opportunity at this level, provides diversification, and hedges your risk to both the equity market and dollar.

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.

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