Ever since currencies floated more than 35 years ago, their action mirrored that of a pendulum, swaying from one extreme to the other. To be sure, there were minor counter swings along the way. Just as the motion of a pendulum is predictable, so is the motion of currencies, although not with the same precision.
Currency extremes have many attributes, the most discernible of which is the fact that the accompanying market expectations are so one-sided that it seems hazardous to take the opposite side. Many have used the example of a rubber band — it can only stretch so much before it snaps back. The problem here is that at times, the rubber band has been exchanged for a bungee rope.
For the first two years as an actual currency (2000-01), the euro traded in a range between 0.83 and 0.95 to the dollar. In January of 2002, it recorded a closing low of 0.8578. This marked the start of a virtually uninterrupted rise to an all-time intraday high of over 1.60 during the last week of April 2008. Along the way, the most serious setback occurred in the first quarter of 2005, which witnessed a pull back of 14%. Because the bull market in one side of a currency pair is a bear market in the other, the U.S. dollar lost almost half of its value vs. the euro in slightly over six years.
Absent direct government intervention, such massive moves over long periods tend to build a strong following that is not easily shakable. The reversal process is incremental and difficult to identify until it becomes definable.
Yet signs have started to emerge that normally accompany extremes. Too many euro bulls are fully convinced that the 1.60 level will not hold and that the market is going higher. Of course, that is still possible. But price action that usually reflects exhaustion has started to surface. New highs have become more labored and downside momentum seems to be building with every attempt to probe lower. The weekly charts registered an eight-week closing low on May 7 just below the 1.54 level. This number became the first signpost of a critical level that needed to hold. Any violation here would strengthen the bearish argument for the euro. At the close on Friday, June 13, the euro ended the week at 1.5383, thereby confirming the sell signal.
The monthly charts offer a clearer representation of the long-term trend. Here again, prices closed during June below the low of May (which already traded below the April closing low of 1.5563). The event offers an added confirmation of the sell signal generated off the weekly charts.
As much as this commentary is about the technicals, the fundamentals here cannot be ignored. The realities of the euro may eventually trump any technical considerations. The euro is a politically inspired currency and its economic viability is yet to be tested. To be sure, it is a young but flawed currency that will be marking its tenth year in existence by early 2009. The economic needs of its member states are pulling at opposite ends. A good analogy would be to describe the situation of two patients in the same hospital room. One requires cold temperatures to improve but the other needs warm surroundings. Something will have to give. The headlines may not read “The Euro’s Rise and Fall” but instead may read, “The Euro’s Rise and Demise.” And that could come before the euro celebrates the first of its teen years.
