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Except for a few short-term opportunists who’ve taken quick profits amid the market chaos, it’s fair to say every man and his dog is short the euro.
Europe’s common currency is, after all, facing the biggest crisis of its eleven-year-long life, one that is now stirring fears of a fresh liquidity crisis in the world’s banks.
Given the paucity of good policy options for this crisis, where is the euro’s fair value over the medium to longer term? Not surprisingly, currency analysts are calling for a bottom that’s far beneath the euro’s current value of around $1.27. Where they differ is at what level the euro eventually stabilizes and on the speed with which it will get there.
Some have drastic forecasts: Stephen Jen, managing director of macroeconomics and currencies at hedge fund BlueGold Capital Management, sees the euro dropping to parity against the dollar in just a few months. The sovereign debt crisis will lead foreign central banks to shun the euro as a reserve currency, he said.
BNP Paribas analysts have the same target but a longer time frame. According to a recent research note, they see the euro crossing the $1.00 threshold in 2011, partly because the crisis has meant that “European bond markets are no longer a homogenous entity,” which portends a decline in capital flows into the euro.
While those calls may seem extreme, it’s worth noting that the euro is still significantly overvalued by various measures.
According to purchasing power parity, which takes account of different currencies’ spending power, the euro’s fair value is just above $1.16, says Win Thin, a currency strategist at Brown Brothers Harriman. Conveniently, that’s also the level at which the euro was launched on Jan. 1, 1999.
In fact, the euro’s long-run average value is near the same number, at $1.20, a figure that takes into account a range of values between its November 2000 low of $0.84 and its July 2008 high near $1.60.
David Gilmore, a partner of Foreign Exchange Analytics, points out that markets don’t typically revert back to the mean and then stay there. They tend to overshoot. So, he thinks the euro could perhaps get to $1.10 before it stabilizes.
Why the unanimous pessimism?
In part, it’s because the euro zone’s unwieldy political structure is preventing its policymakers from acting aggressively enough to prevent a sovereign debt crisis that began in Greece from bringing down other euro-zone countries and the banks that lent to them. That goes for German Chancellor
Angela Merkel as much as it goes for ECB President Jean-Claude Trichet. Yet it is also because the aggressive solutions available–especially that of having the ECB purchase euro-zone governments’ bonds–are themselves inherently euro-negative.
It’s Catch-22: The only way to contain a euro weakening crisis is to do something that weakens it further.
On Thursday, Trichet said the ECB didn’t even discuss the idea of outright bond purchases during an earlier meeting and instead declared the ECB to be ”inflexibly attached to price stability.” In so doing, he demonstrated the ECB’s deep fear of having to monetize euro-zone sovereigns’ debts and of the inflationary effect this could have.
Even so, the liquidity crisis will become so severe that the ECB will eventually have to “hold its nose and undertake euro-style quantitative easing” in this way, Citigroup chief economist Willem Buiter said at the Council on Foreign Relations in New York Friday. And once the ECB does pump fresh euros into debt markets, currency traders will have no choice: They will sell the euro.
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The sentiment was massively negative on the Euro when it was at $1.35. On its initial approach to $1.32, I loaded up quadruple my usual lot size in a long Euro position exactly at $1.3220 because of the sentiment. It should have already been trading below $1.30 and it wasn’t which made me believe that the bulls had control of the Euro and that a long-term reversal in trend was about to take place which would begin with a short squeeze. Well, $1.32 was an extremely important technical level and it had to hold, no questions. When it didn’t my stops went off and I lost quite a bit of money but that little foray told me exactly where the Euro was going and I immediately loaded up on the short side. I covered 75% of the position at $1.2750 with the other piece left with a breakeven stop making far more than I initially lost. The problem with the initial trade is that everyone was looking at sentiment and saying it was too negative including me but obviously that was not the case. The fact is there are probably too many out there who are going long the Euro because of CFTC sentiment which is a giant mistake and you have various entities exploiting that and it’s likely they will continue to exploit this trade all the way down until the Euro is either decimated or done away with. This is an end game trade very similar to Lehman Brothers or Bear Stearns where based on sentiment you would have bought many times at horrible prices as the stock went to zero or I guess $10 in Bear Stearns case. Very dangerous markets and you don’t want sentiment to be the sole trigger in your trading.
He of course being Trichet.
Holy tutorial Batman! Just one question: What paper does he buy to execute QE?
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