Trading Desk Notes - May 26thSubmitted by Polar Futures Group on May 28th, 2018
EUR/USD has dropped from over 1.25 to below 1.17 (~7%) in the last 9 weeks...closing this week at 7 month lows as political/economic developments in Italy herald a potentially existential crisis for Europe as “contagion” fears start to creep into the market.
The EUR/USD 1.25 Inflection Point on Feb 16/18 came after the Euro had rallied against the USD for 15 months...but even then EUR/USD just dropped back a bit and chopped sideways for 2 months while EUR/CHF (a real barometer of Euro tensions) kept going higher...obviously there was nothing to worry about!
But finally, in late April, the damn broke and the Euro started to fall. (See my April 21 TD notes – “It doesn’t matter until it matters, and then it really matters.”)
The initial leg down in the Euro from mid-April through early May came as the USD rallied (bounced back) against nearly all currencies but lately it’s been a case of Euro weakness not simply USD strength as markets become increasingly worried about, “How bad can the Italian problem get?” For the past few weeks I’ve commented on how the Swiss Franc was gaining on the Euro as capital sought safety – even if it meant negative interest rates!
Throughout 2017 and into the first months of 2018 speculators built a massive net bullish position in Euro futures as EUR/USD rose from around 1.05 to 1.25 even though USD interest rate premiums kept getting wider and wider. Speculators ignored the March 4/18 Italian election...but since mid-April there has been relentless selling of the Euro...in part due to the unwinding of these bullish positions...and the data shows that there still remains a large net long position that is at risk of “throwing in the towel” if the Euro keeps falling.
I’ve been a currency speculator for more than 40 years and I’ve learned (and thankfully, remembered) a few things. At the top of my list is the belief that currency market trends can go way further than seems to make any sense...and then turn on a dime and go the other way. In early 2017 as the USD Index fell from 14 year highs I thought it was just a correction after a multi-year rally...but as the USD Index downtrend continued I was puzzled as to why anyone would want to exchange US Dollars for Euros or any number of other currencies. I was US Dollar bullish in 2017 but the price action told me that I was wrong. But now the price action is telling me that the US Dollar is likely to go higher.
How high? Martin Armstrong recently wrote that if EUR/USD breaks a monthly bearish reversal at 1.1552 it will, “Signal the start of the dollar rally which looks like it will peak in 2020 – 2021.”
WTI Crude Oil hit a fresh 3 ½ year high early this week but then fell more than $4.50 on fears that OPEC and friends might agree (at their scheduled June 22 meeting) to increase production to make up for declining production from Venezuela and (potentially) Iran. I’ve described the crude oil market as having a “relentless bid” the past couple of months as prices moved higher and higher...now I’m wondering if crude has hit an inflection point and is going to have a big drop. There has been a massive buildup of spec longs in the futures market (yes, it’s dropped a bit the past couple of weeks but it’s still HUGE) and if those buyers start to hit the bid prices could really take a tumble (especially if the USD keeps going higher.)
Contagion risk in interrelated markets: I pay a lot of attention to intermarket relationships because a significant move in any market will have “consequences” in other markets. I also pay a lot of attention to market psychology which, at extremes, is basically capital moving back and forth between Fear and Greed. If a market gets “too greedy” I wait for a signal that things are about to change...and nothing creates change in a “too greedy” market faster than fear. For instance, I think the relentless widening of the USD interest rate premiums over Euro area interest rates had “consequences” for the EUR/USD exchange rate...and, finally, the Euro fell...and as it fell “fear” replaced “greed” in a market that had been driven too high by “greed.”
The potential existential crisis for Europe is essentially the fear of, “What happens if the market begins to believe that Italy will leave?” We’re seeing an early answer to that question with capital leaving the Euro for the Swiss Franc...with Italian (and other Euro area countries) bond yields rising against German yields.
For decades after WW2 Club Med countries devalued their currencies to remain competitive with Germany and to maintain a “lifestyle.” Under the Euro the “shock absorber” function of currency devaluation is not available...so what absorbs the “shocks?” The ECB has helped by buying Club Med bonds but the people are voting for “change” and that stress is starting to show up in the markets. But what if the stress level increases? Perhaps then the US Dollar really starts to rally...and what does that do to Emerging Market debt or equity markets?What does that do to the cash flow from foreign sales of the S+P 500 companies? What does that do to the price of gold...especially gold priced in terms of Euros?
Charts: Both WTI and CAD registered a Weekly Key Reversal Down on the charts this week while YEN (and nearly bonds) registered a weekly Key Reversal Up.
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