Euro Drop A Sign of Things to Come?



So far this month, some of the biggest moves in the forex markets have been tied to the Euro. The EUR/USD had previously posted a steady advance toward the 1.40 mark but changing central bank expectations led to sharp bearish reversals. The fact that 1.40 was never pierced in the EUR/USD means that we now have a very clear “line in the sand” and the overall bias will remain bearish as long as we hold below this level.

There is a wide variety of reasons for why the Euro is unlikely to rally any time soon. For those with long-term, fundamental perspectives the highest point on this list should be the fact that there is little evidence to suggest that the region has successfully recovered from its sovereign debt crisis. Unemployment and overall growth levels as measured by GDP are still stalling, and when we compare the data to other developed economies there is little in the way of substantive explanations for why the EUR/USD has rallied as much as it has.

ECB Policy Stance

It has taken a while for the data to filter into monetary policy commentaries from the European Central Bank (ECB), but that time has come as well. “Recent statements from voting members at the ECB suggest that the central bank is prepared to add more stimulus to the economic if macro data worsens,” said Rick Bartlett, markets analyst at Corner Trader. “Regional unemployment still stands at 11.3%, so there is a good chance we will see these types of activities taking place.” Of course, added monetary stimulus would be a significant negative for the Euro, as it would essentially mean that there will be more Euros flowing through the world economy.

Going forward, the fate of the Euro will rest almost directly on the ways the ECB will choose to outline their policy stance. It is entirely possible that we will see some decisive moves as early as next month so those trading the EUR/USD should prepare for added volatility that is not commonly seen during the summer months. For investors that are mostly focused on stocks and ETFs, a good way to monitor the behavior here is to watch the Guggenheim CurrencyShares Euro Trust (FXE).

But since currency flows will always require money to be exchanged from one currency to another, investors will also need to be aware of activity in the PowerShares DB US Dollar Index Bullish ETF (UUP) and the Guggenheim CurrencyShares British ETF (FXB). The British Pound and the Euro have a high positive correlation, so if we do start to see major failures in the Euro-backed assets, we can start to expect the same thing to happen in the ETFs that are backed by the Pound. Most market wisdom suggests that we are heading into an historically slow period, but the ECB has the potential to change these tendencies in the next few weeks.

Richard Cox is a university teacher in international trade and finance, and his lessons include macroeconomics and price behavior in equity markets. He also writes for various financial publications across the web, and his investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities).