About this time last year, we made the case against the euro based on a required extension in the currency’s cycles. As “Time to reverse?” shows, the euro has had three major down cycles and two major up cycles since the summer of 2008: -23% from July to October 2008; -21% from November 2009 to June 2010 and -19% from May to July 2012.
Is the euro now ready for a rising cycle? There are technical and fundamental factors that lead us to believe EUR/USD is at the start of a secular bull move.
The EUR/USD not only has held consistently above its 200-month simple moving average, but also rebounded right off the key monthly moving average. The 200-month simple moving average can be powerful when it reconciles with cycle turnarounds. Over the last nine years EUR/USD has held consistently above its 200-month simple moving average.
Since 2003, EUR/USD tested, without breaking, its 200-month SMA on three occasions: November/December 2005, June 2010 and August 2012.
Nov/Dec 2005: The European Central Bank (ECB) began a three-year tightening campaign. Six months later, the Fed halted its tightening cycle. The diverging interest policies were a significant boost for the euro. EUR/USD rallied 37% in the subsequent three years.
June 2010: The euro’s bottom coincided with chatter of a second round of quantitative easing (QE2) by the Fed, Beijing pronouncements about purchasing Eurozone bonds and stabilization of Spanish unemployment. EUR/USD went on to rally 25% for 11 months.
August 2012: Euro bottomed on ECB verbal/operational support for Eurozone and the Fed’s QE3. After the August bottom, EUR/USD rallied more than 10%.
Another remarkable feature of the EUR/USD rebound is the rare monthly reversal occurring in September. The rebound is a reversal of a 16-month downtrend. Combining major trendline reversals with key moving averages underlines the case for a potentially solid secular bull market in the euro against the U.S. dollar.
The fundamental case also can be powerful in explaining money flows, but not always effective in timing. The ECB’s Outright Market Transaction (OMT) program stands out from prior bond purchase plans via its ability to combine conditionality, sterilization and unlimited purchases. Most of all, the OMT has integrated monetary policy into fiscal policy, i.e., requiring nations to abide by fiscal rules in order for their bonds to receive monetary stimulus. The OMT may not be a direct solution to Europe’s high debt/low growth problem, but it buys invaluable time for national governments to pursue their austerity policies by keeping yields in check and markets supported.
As for the Fed’s QE3, it stands out from previous programs in its open-ended nature to target the labor market and its willingness to see inflation surpass 2% with the aim of reducing unemployment below the stubborn 8% figure.
Another remarkable attribute of the Draghi/Bernanke policy combo is that rarely have the markets rallied ahead of anticipated policy measures and continued to do so after their materialization. And so it happened; Draghi vows to spend unlimited amounts to drag down bond yields and Bernanke is willing to extend monthly purchases indefinitely — until unemployment declines and remains at or below 7%.
But for the ECB’s shock and awe OMT program to be activated, a country must request assistance from the European Financial Stability Facility fund, later to become the European Stability Mechanism. At the current juncture, Spain is the nation mostly in need of official help. As long as Madrid refuses to ask for help, speculators will find a motive to attack its bonds and for the Eurozone bond market to lack the required dose of ECB purchases. In the event that Spain’s obstinacy towards a bailout leads to a deterioration of Eurozone conditions and Greece fails to pass the €11 billion ($14.3 billion) in budget cuts, the euro’s upside path could become seriously challenged.
The combination of aforementioned technical indicators with the ECB’s conditional policy stimulus and the Fed’s open-ended balance sheet expansion paves the way for the next $1.35-bound move. Such positive assessment for the euro is not without risks. In order for the three-month uptrend to remain intact, EUR/USD must continue to close above $1.2650. We have seen false rebounds before, but never such a monthly reversal coinciding with yet another bounce off the crucial 200-month moving average. With the central banks willing to cooperate, euro technicals also may be willing to move along.
Ashraf Laidi is chief global strategist at City Index-FX Solutions and author of “Currency Trading & Intermarket Analysis.” His Intermarket Insight appears daily on AshrafLaidi.com.