Is the euro the ultimate bearish idea?

October 17, 2016 01:00 PM

Since the drastic drop from 1.40 to 1.05 starting in May 2014 and culminating in March 2015, the Euro/U.S. dollar (EUR/USD) currency pair has essentially been experiencing range-bound trading. This has been due to market uncertainty, as to which central bank will try to lower their interest rates more drastically: The U.S. Fed or the European Central Bank. At this point, the market appears more confident that the U.S. economy will outperform the Eurozone, especially in light of the Brexit. Therefore, look for the EUR/USD to test the bottom of its range at 1.05, and possibly head to parity at 1.00. 

The U.S. economy has indeed improved during this range-bound period, with the unemployment rate steadily going lower, along with the U.S. housing market looking extremely strong. This alone may be the impetus for a USD rally versus the euro, not counting the potential of further stimulus from the ECB going forward. 

Technically, the EUR/USD is well below is 200-week moving average, and has been below this key internal benchmark since August 2014. This presents a very bearish technical argument for lower prices ahead (see, “Trouble ahead” below). The weekly chart shows that there is a downward channel which started in May of this year, as well as some key target levels if the 1.05 level is broken to the downside. The EUR/USD is in sell-the-rally mode.

There has not even been a whiff of inflation in the Euro region and the economy has been lackluster. The ECB seems very committed to providing as much stimulation via bond buying as possible in order to stoke the economy and bring back demand. Keep in mind that ECB President Mario Draghi said that he will do “whatever it takes” to stimulate the economy. Contrast this to the U.S. economic environment, which has been steadily improving during the last several years. Even though inflation is not roaring in the United States, we have seen wage growth begin to tick higher 

(several large U.S. companies have increased their own minimum wage), and U.S. housing, arguably the most important indicator following the 2008 crisis, is improving. Furthermore, the U.S. Federal Reserve has become increasingly vocal that a rise in interest rates is relatively imminent, which was emphasized by Fed Vice Chair Stanley Fischer during a recent interview at the  Jackson Hole Summit. 

Finally, we believe that U.S. assets in general will continue to be a safe haven for global investors in light of the structural changes in major European economies brought on by Brexit, as well as the uncertainty that surrounds the Chinese growth story, which also affects numerous other emerging markets. As the dollar continues to be a safe haven, U.S. stock and even bond prices may continue to rise, eventually causing the Fed to resume a tightening regime begun in December 2015, further depreciating the Euro versus the U.S. dollar.

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