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The Big Euro Squeeze

by Rafael Rosa on March 26, 2010

squeeze me The Big Euro Squeeze

The Euro-dollar (EUR/USD) is hanging out around  its 2010 low. Debt concerns regarding Greece and other European countries has ripped the Euro apart. Additionally, as mentioned before, everyone and their grandmother is short the EUR/USD.

There is no doubt that the Euro-dollar is in a strong downtrend and possibly looking to crack the 1.3200 and 1.3000 levels in the very near-term. Besides the sovereign debt concerns, other factors such as interest rate differentials and a strong U.S. economy are supporting the dollar. In regard to yields, U.S. Treasury yields have been “soaring”, with the 10-year Treasury yield attempting to once again crack the 4% mark.

The Euro is also far away from key technical levels that would indicate an end to the downtrend. Most traders claim that a daily close above the 1.3820 level or so would put an end to the  downtrend. At 1.3300, that’s quite a few pips away.

Nevertheless, one must always look at the other side of the pond. Currently, the only perspective you get on the Euro is “down, down, down”. Traders with those preconceptions also end up only looking for evidence that confirms their view, which is something humans do for most things in life. Nobody wants to hear about the positive upside in the Euro because “everyone knows” the Euro is going to collapse. Some hedge funds are even looking to cash in on their “career trade” as they bet the Euro will retrace back to 1.000 against the U.S. dollar.

So, what are the catalysts that would create some upside for the Euro?

First, we have to acknowledge that most of the Euro losses have stemmed from doubts and concerns over what will be done with Greece. Uncertainty, which markets hate and punish, has been the leading factor in bringing the Euro down. Nobody really knows what is going to happen and as a result traders end up pricing in the worst case scenario.

Uncertainty, combined with massive short positions, opens up room for something a lot of traders hate: the big short-squeeze. Not a 50 pip squeeze, but a 300 or 400+ pip  squeeze. Hence, when you take out uncertainty (think ‘healthcare reform’), the currency markets may be ready to give the Euro some slack.

Second, we’ve been told it’s the end of the world for the Euro-zone. While some headwinds do play out at times (e.g. tech bubble bust, real estate bust and financial crisis), most end-of-the-world scenarios never materialize (thus the term “headwind”). Nevertheless, experts have taken out their forecasting tools and drawn a line forward predicting a “Euro-crisis”. As mentioned before, the “US dollar crisis” in November 2009 was all too similar. As the Dollar Index reached the 74 level, hysteria had taken over and doom was the only path for the dollar. As we can all remember, experts, gurus, and the Kudlows of this world had a myriad of reasons as to why a collapse of the dollar was certain. Too much debt, too much issuance, hyperinflation, double dip, China takeover, the Euro as the new reserve currency (LOL ?), etc, etc, etc. We all know what happened.

The Euro is now holding the hot potato. The consensus is that the collapse of the Euro is imminent and that nothing can be done. Yes, the Euro can collapse. But all you need is some gentle words from Germany or France regarding bailouts and the Euro (in the short-term) would likely bounce like a squeaky ball.

In the longer term (a few months ?) the Euro may drop substantially if the worst case scenario plays out. However, most FX players are not investing in currencies but rather trading shorter-term horizons. Five-hundred pips against you and you’re probably deep in the red. Therefore, paying attention to potential short-squeezes in the next few days and weeks is essential. Once again, don’t let the bears consume you.

I don’t quite recommend going long the Euro, but I do promote locking in profits and using them stop-losses.

On this note, time to bring out my Dollar hat again.

us dollar index 90 hat 5 The Big Euro Squeeze

Technorati Tags: Currency Trading, dollar index, eur/usd, euro, euro collapse, euro dollar, euro short squeeze, fx trading, headwinds, short squeeze

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