COFER: Indication Of Euro Strength Against The U.S. Dollar

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Includes: EU, FXE, TLT, UUP
by: Katchum

The new numbers of the Currency Composition of Official Foreign Exchange Reserves (COFER) have been released and it shows that the world has stopped selling euros (Table 1). Claims in euros have increased from $US 1.413 trillion to $US 1.423 trillion, an increase of 0.7%. Claims in U.S. dollars have increased from $US 3.513 trillion to $US 3.548 trillion, an increase of 1%. Interestingly, the increase in U.S. dollar claims is flattening out as compared to previous quarters, indicating U.S. dollar weakness.

In the previous three quarters, the claims in euros had been going down ($US 1.472tr in Q2 2011 to $US 1.438tr in Q3 2011 to $US 1.413tr in Q4 2011). But that decline has stopped for now. I believe this reversal means that it's time to start buying into the euro again in the short term.

Table 1: Currency Composition of FOREX Reserves

If we look at the technical picture for the euro we can see that we are approaching the bottom of the channel in the EUR/USD exchange rate chart (Chart 1).

Chart 1: EUR/USD exchange rate

I wrote about the correlation between the EUR/USD exchange rate and eurozone bonds in a previous article. Based on that article, I believe now is the time to sell U.S. government bonds (NYSEARCA:TLT) for eurozone bonds (NYSEARCA:EU), because we are going into a period of euro strength. Chart 2 gives evidence to this claim: the red graph is forming a top, while the blue graph is forming a bottom.

Chart 2: iShares Barclays 20 Yr Treasury Bond VS. Wisdom Tree Euro ETF

On the fundamental side of the currency markets we note that the ruling on Obamacare will have significant impact on the U.S. dollar. Douglas Holtz-Eakin, former director of the Congressional Budget Office, estimates that the change would result in increased annual expenditures of up to $US 100 billion. This increase in budget deficits will weaken the U.S. dollar and U.S. bond markets. $US 100 billion should not be ignored, because it is 10% of the current budget deficit. As a result, the euro posted its biggest gain against the U.S. dollar since October 2011 (+1.79%) (Chart 1). Gold was up 3% on debt worries due to the Obamacare ruling.

Conclusion:

Based on the fundamental and technical analysis of the EUR/USD, I believe the euro will strengthen in the short term.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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