What’s behind the big drop in the euro?

COT Data

You can see on the weekly chart the massive shift of “big money.” On Sept. 2 commercials were -3,154 contracts net-short and one week later on Sept. 9, this past Friday, we saw commercials come in at 45,744 net-long. A big money postured to drop the euro. Look at the time between December 2010 and mid-January 2011 when commercials were last net-long and the euro dropped to 1.3000. Even more eye opening, look back from January 2010 to August 2010 when commercials reached a net-long position of over 100,000 contracts. Look where the euro got down to back then. Just how committed is big money to dropping the euro? Well, this past week they took one big step, we will have to wait until next Friday to see if they take another big step. Of course any positive news from Europe would help stop the drop, but how many more rabbits does the ECB have left to pull out of their magical hat?

Commercial Net Tracker instructions: This form tracks the Commitment of Traders (COT) data for the commodity futures market. This form "looks" at the most recent five weeks of COT data and provides visual indications of the data. A) If the current value is at a 12-month low, the cell will display a red/burgundy background. B) If the current value is at a 12-month high, the cell will display a green background. C) If the current value went from net negative to net positive, the cell will display a blue background (indicating a bullish condition). D) If the current value is both a 12-month high and also went from a net negative to a net positive, the background will be green. You should view the data with green backgrounds to determine if they also went from net negative to net positive.

If you need help understanding how to understand how to use the COT report to your benefit, please email me at Gary@crbtrader.com and put COT report in the subject line. Please include your name and telephone number in the email.

Proceed to Page 3 for this week's detailed fundementals charts...

Fundamentals

The EUR/USD has fallen sharply in the past week and posted a new two-month low. EUR/USD has so far only moved toward the lower end of its narrow four-month trading range, but now has the potential to break out of that range to the downside. We remain long-term bearish on the dollar index overall. However, EUR/USD still could see a multi-month downside correction of the big rally seen from June 2010 to April 2011.

We are turning more bearish on EUR/USD for the medium-run because of the fact that the European Central Bank (ECB) has been forced to turn more dovish as the European sovereign debt crisis has spread to European banks. One or more Eurozone sovereign debt hard defaults has become almost certain and the panic has spread to European banks because most European banks hold large amounts of Eurozone government bonds. The most ominous recent development is that Italy and Spain have been sucked into the vortex with record highs in their CDS prices. There is no way that Germany and France can or will bail out all of the PIIGS countries, which together account for 34% of Eurozone GDP. German and French debt credit quality has been called into question with Germany CDS prices only seven bp below the recent 2-1/2 year high of 85 bp and French CDS prices only 14 bp below the recent record of 187 bp. The ECB is barely holding the Eurozone situation together with its purchases of Spanish and Italian debt while Eurozone politicians dither on approving the second Greek bailout and the expanded duties of the European Financial Stability Fund.

In this environment, the ECB at its meeting on Sept. 8 turned neutral on its inflation risk assessment, which would be the intermediate step if the ECB is forced to cut rates in coming months. There is now a better than 50-50 chance in our view that the ECB will cut its refinancing rate by 25 bp by the end of this year. The ECB likely now recognizes that it was a mistake to raise its financing rate by 25 bp in April and by another 25 bp to 1.50% in July in the midst of the European debt crisis. With support for the euro from interest rate differentials now waning, we think the euro has some significant downside risk. The U.S. is not in great shape, but at least its banking system is not currently in a crisis mode.

Have a prosperous trading week.

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