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Six Reasons We're Bearish the EUR/USD For the Coming Months




EUR/USD For the Coming Months

Here's the trend for the EURUSD for nearly the past year.

EUR/USD DAILY AVAFX CHART 01 FEB 26

While neither the US nor EU is expected to show significant improvement in the coming months, we expect the US, and thus the USD, to perform better, thus pressuring the pair lower. Reasons include:

The Overwhelming Power of the EU Debt Mess- The latest bad news includes:

Note that the above Chart began to rollover as the Dubai World debt crisis in late November 2009 brought the EU's also immanent default issues to the attention of previously sleeping ratings agencies and financial media, which were now determined to not get caught unawares yet again.

Standard & Poor’s warned that Greece could face a 1 or 2 notch downgrade in a month if they do not get their act together. According to S&P, “Downside risks for Greece’s real and nominal growth are likely to increase the size of needed fiscal consolidation, raising questions about the feasibility of the country’s ambitious budget goals,” and “Political risks" may impede "the timely implementation" of the "fiscal reforms."

In addition, Moody's too warned of a possible credit rating cut for Greece. This is significant because they give Greek bonds its only remaining A rating. Below that rating, Greek bonds will not be adequate collateral for ECB borrowing.

The WSJ has also warned that Spain could be the next problem area in the Euro zone.

Technical Oversold Indicators On the Euro Don't Mean Much In A Strong Trend

While the now perpetually short term oversold nature of the Euro always gives potential for a short term bounce, the US Dollar's 9 month descent showed how long a currency can remain "technically oversold" when fundamentals behind the move remain, and the dollar's travails last year are a good illustration of how the various oversold/undersold indicators like oscillators are of limited value in a strong fundamentals driven trend. These indicators are more useful when an instrument is in some kind of shorter term trading range.

Other EU Fundamentals Behind the EUR/USD Downtrend

Meanwhile, overall Euro-zone confidence, employment, growth and inflation numbers remain weak compared to those of the US. For example, forecasted EZ growth is about 0.7% vs. the Fed expected growth for the US to be 2.8 - 3.5 percent this year.

While both regions have issues with deficits, the EU is clearly seen as being in worse shape due to PIIGS severe deficit troubles. The EU is worried about “serious adverse risks” in the financial markets and mounting concerns on sustainability of public finances. The inevitable forced spending cuts and/or tax increases needed to rein in their deficits, will just as inevitably hurt EU growth as the lesser evil of sovereign bankruptcy, or at least prolonged bankruptcy.

Remember that while the current focus is on Greece due to its impending maturing bond payoff, many do not even see Greece as the main problem, but rather as a small part of the larger deficits among the PIIGS block. Portugal already had a failed bond sale. Reuters reported in mid February that famed hedge fund and currency investor George Soros questioned the long term viability of the Euro, saying that "A makeshift assistance should be enough for Greece, but that leaves Spain, Italy, Portugal and Ireland. Together they constitute too large of a portion of euro land to he helped in this way." Others look at Italy, with the second largest debt to GDP ratio, as the biggest concern. Its debt is purportedly 25% of the entire EU debt outstanding, whereas Greece's is far smaller.

Odds Favor Risk Aversion Trends For the Coming Months- Which Favors the US Dollar Over the Euro

The US Dollar does better than the Euro in times of fear. Because the EUR/USD is about 33% of all forex trade, the two currencies force each other to move in opposite directions like children on a seesaw. Reasons we don't see much upside for risk assets like the Euro in the coming months include

The EU debt mess is getting worse, and unless markets are calmed risks a market collapse and credit freeze up at least on scale with that caused by the collapse of the laughably much smaller Lehman Bros. bank.

Cooling China growth likely to slow down as the Chinese government openly eases back on Chinese growth

US financial system faces its own troubles

From possible waves of state and city deficits, commercial real estate mortgage defaults, all of which will further pressure a much stressed banking system. Further bailouts are not out of the question. That would hurt not just the dollar, but global risk appetite as well. Not surprisingly, US bank credit continues to shrink

US bonds continue to soak up much of bank funds available for credit due to their relative safety, crowding out businesses needing credit

US jobs and spending data, the key metrics to the US recovery, are struggling to maintain their uptrend (i.e. of 'lower declines). The service sector, by far the largest pool of jobs, is suffering more job cuts than manufacturing.

( For further details on the US's struggles, see Dave's Top 10 Reasons to Fade the Recovery (Remember, It's Not a Business Cycle)

Other Technical Indicators Suggest More Downside Ahead

In addition to the steep downtrend and long period spent in its lower Bollinger Band range, there are a number of disturbing technical indicators. For example, the 50 day SMA (red line) has long ago crossed beneath the 200 day SMA (purple line) creating an ever-widening 'death cross' that suggests a longer term downtrend.

In sum, the EU faces relatively greater obstacles to recovery in the coming months. We may well see that relative strength of the US vs. the Euro play out in the regional stock markets as well.

In the long run, we continue to expect the euro to underperform the dollar.

LONG UUP

SHORT: FXE UDN ERO FXB FXC

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