A Lower Euro Can Benefit Investors, Not Just Tourists

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Includes: FXE, UUP
by: Bret Kenwell

Summary

The ECB's quantitative easing measures are improving the European economy, but hurting the euro.

An improving U.S. economy should boost the U.S. dollar, aiding in a lower euro.

An improved economy back home would justify higher interest rates, also boosting the value of the U.S. dollar.

I first want to say that I'm far from a currency expert or FX trader. While I generally seek out opportunities within businesses and stocks, short- to intermediate-term opportunities do arise. In this case, I believe there is an opportunity to sell short the euro.

While the currency may gyrate either up or down over the next several days, weeks or possibly even months, I feel that the ultimate trend is to the downside. While the European Central Bank's quantitative easing measures are being used to boost the economy (which appears to be working for the most part right now), it comes at the sacrifice of the region's currency.

A lower euro also seems to be the consensus when listening to conference calls of management teams from top companies with multinational exposure.

Greece

While the Greek debt situation never seems to go away, a debt solution seems like it will bode bearishly for the euro. That's because Greece is a weak economy and its exit from the eurozone will bolster the strength of the currency. Likewise, Greece staying in the eurozone will likely weaken the currency. Because European exporters are enjoying a weak euro, many nations, such as Germany, would prefer that Greece stays in the eurozone.

A potential risk lies in the event that at some point down the road, a Greek exit from the eurozone will boost the euro currency, because the eurozone will then be economically stronger.

The Dollar

While the euro could appreciate against other currencies, I am looking for it to decrease against the U.S. dollar. In this situation, the euro doesn't have to do all the work. In other words, it would be nice for the U.S. dollar to appreciate due to its own catalysts, rather than simply benefit from bearish situations for the euro.

An improving U.S. economy should help boost the value of the U.S. dollar and in our case, will also likely lead to higher interest rates at some point. Increasing interest rates also tend to boost the value of a given currency.

On Friday, we saw what could be a preview for a higher dollar, as the non-farm payrolls report for the month of May came in at 280,000 jobs, ahead of economists' expectations for 225,000. This sent the PowerShares USD Bull ETF (NYSEARCA:UUP) up by about 1% and the CurrencyShares Euro Trust ETF (NYSEARCA:FXE) down by roughly the same amount. The response was likely twofold: The economy is improving and the chances for a rate hike have increased.

While a rising rate environment stands to act as a catalyst for a higher U.S. dollar, it can also pose a risk: When exactly the Federal Reserve will raise interest rates. While there has been much speculation about raising rates in September or December, the International Monetary Fund recently warned that the Fed should wait until the first half of 2016.

If the economy takes a turn for the worst or if the Fed does not feel comfortable with raising interest rates for quite some time, it could act as a negative catalyst to the U.S. dollar. A declining dollar would pave the way for a stronger euro, hurting our short position.

Conclusion

In my opinion, I feel as though there are several "trend" catalysts working in favor of a lower euro. In other words, if the current trends continue (such as a rising U.S. dollar, eventual rate hike, continued QE from the ECB), then the euro seems likely to head lower.

There are risks in shorting the euro however, and that comes from a delayed rate hike from the Fed and possible Greek exit from the eurozone. In my opinion, the catalysts for a lower euro outweigh those for a higher euro.

The consensus seems to be that the euro is headed to parity with the U.S. dollar, (that is to say, 1 USD is equal to 1 EUR). The timing is the only question mark in the theory. Shorting can be seen as risky, especially when done without discipline.

For me, I don't use currency pairs or futures to gain exposure, as I simply stick with ETFs like the UUP or the FXE. In this case, I have used the FXE and rather than shorting the ETF outright, I have decided to purchase long-term put options on the ETF instead, which expire in January of 2017. I felt that this best limited my risk, while still allowing me to gain exposure to a short euro as a speculative position in my portfolio.

Disclosure: The author is short FXE.

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.