Euro: Time To Take Profits

During third week of March I had argued that the Euro’s spike up against the Dollar would not last and

recommended shorting the Euro against a basket of currencies dominated by commodity driven currencies like the Australian Dolla (FXA) and the Canadian Dollar (FXC). I had added a comment to relative underweight of the Canadian Dollar in the long portfolio since the Canadian Economy is perceived to be closely linked to the US economy.

Since that period, not only have the commodity driven currencies outperformed the Euro, but even the US Dollar has performed better.

FXE vs FXA and FXC

High Resolution Image Here

Euro Zone: No Better than the US

The Euro Zone suffers from similar problems as the United States when it comes to an overleveraged financial system, loans gone bad (Eastern Europe) and a slowing economy. The challenge faced by the European institutions is probably worse than the US institutions on a relative basis since the economies are not as big (think Iceland). Above all it is the lack of political consensus and a single sovereign decision making entity which make it much harder for the European nations to react to the challenges thrown up by the current crisis. As a result Europe has behind the curve when it comes to remedial actions.

So whatever negative impact the US policies may have on the Dollar, will also show up in the Euro with a time-lag.

For example, after the spike in the Euro following the Fed announcement of Quantitative Easing, the Euro fell after the ECB hinted that it might buy commercial paper and corporate debt. Unlike the US Fed, the ECB can not buy bonds directly from EU

governments and buying the debt in the open market will raise a political issues since there are so many governments to buy from.

Profit Taking Time

The Euro has fallen about 8.5% against AUD, about 4.5% against the CAD and 3.5% against the USD since March 19.

On Thursday the Euro dived further after economic data from the US turned out to be less bad than the data

from the EU.

There might have been a flight to safety trade into the USD since we

were going into a long holiday weekend.

Given the large moves, I have decided to take profits on this trade. The Euro is now trading close to the level prior to the Fed’s Quantitative Easing announcement. The Thursday sell-off in the Euro was also showing divergence with the performance of

the US Equity Markets which jumped up big after the earnings pre-announcement from Wells Fargo (WFC) and better than expected Job Loss data.

The Euro has had a strong positive correlation with the performance of the US Equity Markets.

If the stock market rally continues next week,

the Euro might get some bid.

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