Much of 2009 saw a major appreciation of the Euro, and decline in the USD. Because the EUR/USD pair alone comprises about 33% of all forex trade per recent data. Thus the two currencies push each other in opposite directions like children on a seesaw. Thus the story of 2009 Euro strength was mostly a story of US dollar weakness, as growth rates were fairly comparable.
The same is true for the current rally in the US dollar and decline in the Euro, only this time it’s a story of relative Euro weakness forcing a reversal of these trends.
More precisely, trends in both of these currencies have simply been a symptom of overall risk appetite. The Euro rises in times of rising stocks and risk appetite as seen from March 2009 until the past months. The US dollar in recent years rises in times of fear. Leave aside the technical explanations for now.
Similarly, as fear has hit in the wake of Dubai and EU sovereign debt default concerns, China growth cooling, etc, the fortunes of the two currencies has reversed.
Thus, if you understand that the Euro and Dollar move according to risk appetite, it won't be hard to understand what key factors to watch for anticipating reversals in these currencies and other risk assets like the Euro, or safe haven currencies like the dollar.Trend Reversal Drivers
In order to attempt to time the eventual reversal in the US Dollar rally and simultaneous Euro rally, look out for the following factors and events.
Sovereign Debt Default Fallout From PIIGS: Until Greece gets bailed out, the path of least resistance for the EUR/USD is down and not up. The fiscal problems plaguing Greece and the other PIIGS (Portugal, Italy, Ireland, Greece and Spain) are deep seeded fundamental issues that are not going away quickly and need to be addressed before markets are again bullish on the euro. According to a report from Bloomberg, investors are pulling cash out of Europe at a record pace as central banks slow their own purchases, undoubtedly due mostly to the risk of investing in the region. The cost of protecting against a default in the Euro zone for 5 years, which is measured through credit default swaps hit a record high last week. Thus the first thing to look for is a credible bailout plan for Greece.
Fear About Cost Of Bailout For Greece, Others: Many believe the time to buy Euros will be when some kind of bailout plan for Greece is announced. However, given state of the other PIIGS group deficits and credit ratings, as well as those of others such as Latvia, what goes for Greece will be expected for the others. That ultimately means a lot more Euros printed and devaluation concerns for the Euro similar to those plaguing the US dollar and British pound. So even if/when a plan comes about, unless it's able to address concerns about the ultimate cost of bailing out ALL of the EU's fiscal problem children, it's very unclear that even a bailout plan for Greece will reverse the Euro's slide. Thus, while the mere announcement of a bailout plan for Greece might provoke a short term rise in the Euro, it won't be enough by itself to sustain a longer term reversal. Watch for a plan that credibly addresses all of the EU's fiscal problem children.
Fears Of Euro zone Growth Lag: Many fear EU growth will lag that of competing regions, particularly that of the Euro's chief counterpart, the US Dollar. If the reverse happens because the strength of the U.S. dollar curbs demand for U.S. exports and the weakness of the euro boosts demand for European exports, then that too might stop the Euro's decline. Also, any weakness in the US Dollar will also help stabilize the Euro, since the EUR/USD comprises 33% of all forex and thus the two currencies force each other in opposite directions like children on a seesaw.
Continuing Technical Weakness: The EUR/USD has been crashing support levels, and starting to show signs of prolonged downtrend as it crosses below key moving averages and price levels, and has begun to show the feared "death cross," i.e. the 50 day SMA crossing below the 200 day SMA. Momentum builds its own value. Any reversal of this by itself is a positive sign for the Euro.
NB: Any other events that restore risk appetite will also contribute towards reversing these trends. For example, stronger than expected growth in China or other key economic regions.
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