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Schizophrenic Trading in EUR Courtesy of Possible Delays to EU Debt Deal

Last updated 10/26/2011 10:11 AM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

It is D Day in Europe. The clock is ticking and in less than 8 hours, we will learn exactly how much progress has been made on the EU debt talks.  The volatility in the euro reflects the mixed messages coming out of Brussels and the confusion that it has created in the market.  Some investors are still holding out hope that this will be Summit to end all Summits and their enthusiasm was supported by the German Parliament's approval of leveraging the European Rescue Fund. This was a necessary hurdle for the EU to overcome and a rejection of the proposal would have had dire consequences for the euro by putting the entire EU rescue package at risk.  Now that the EU has the blessing of the German Parliament, leveraging the EFSF through a first loss insurance will be a key component of the EU's rescue plan.  Yet the problem is that in the eleventh hour, there are too many complications and signs that a deal has not been reached.  Shortly after the Bundestag approval was announced, an EU official said talks on Greek haircuts are deadlocked, forcing the euro to choke up its gains and later on, an EU official said the decision on the EFSF capacity could be postponed to November. The prospect of further delays has reversed the gains in the euro.  Three key decisions need to be made today for the EUR/USD to burst above 1.40. The EU needs to decide on the size of bank recapitalization, how to lever the EFSF (and to what degree) as well as the the haircut for Greek bonds.  The first 2 goals may be achieved but the debate about bond losses could kill the deal today. All EU officials should be locked behind closed doors because there are too many headlines seeping into the markets, resulting in schizophrenic trading in the euro.  We could be stuck with this type of trading for the rest of the day with the EU Leaders meeting scheduled for 15:45 GMT and a press conference not expected until 20 GMT.

Unfortunately more can go wrong than right today and it won't take much to disappoint EUR/USD traders.  If the EU leaves the details to their Finance Ministers, meaning that they fail to deliver hard numbers, the EUR/USD could come crashing down. However it also won't take much to satisfy the market.  As long as bank recapitalizations exceed EUR100 billion, the EFSF is leveraged to more than EUR 1.5 trillion and haircuts are less than 60 percent, investors will be pleased.  Euro area policymakers are fully aware of the numbers that the market is looking for and if they can bite the bullet and agree to deliver on these terms, investors will be relieved. 

It is important to remember that at the end of the day, the Europeans will come up with something.  It may not happen today (EU officials are now saying that the EFSF capacity could be determined in November) but it will happen eventually and when it occurs, a major near term risk will be eliminated from the market, allowing everyone to let out a big sigh or relief that will translate into gains for euro, and other high yielding currency pairs. In the meantime however, put on those tin hats because if the decision is officially delayed, the EUR/USD could slip back to 1.38.

Across the Atlantic, the U.S. continues to report better than expected economic data. New home sales jumped 5.7 percent in September, to a 5 month high.  Although sellers had to reduce prices to move inventory, there are at least some signs of demand recovering.  Durable goods orders also fell -0.8 percent which was less than economists had anticipated.  Excluding transportation, orders rose 1.7 percent, which was the strongest gain in 6 months. 

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Comments (2)

Darkdoji

October 26, 2011 at 11:58 AM ET

They can't fix it. We all know - the Euro has been stalled for days - waiting to do more than we saw today. We talk of haircuts like it is the politicians that need to agree. But it is the banks that need to agree and given the state of the banks that is asking a bit. Nothing is going to be fixed. Germany is not at all helpful - they want to eat their cake and have it - that will not play (morally justified or not). France is in real danger and not getting the support it needs from preachy Merkel (indeed Germany is far too stiff for the union it claims to seek). Greece needs 120% write down from the banks no more no less. Once again they can't fix it you cannot create a union by fiat - involves a lot more and that much is coming clear. We are direct witnesses to the trigger events that will invalidate this huge experiment for ever. Has no basis in reality. A Union of peoples yes - but not a union of governments.

mbrad77

October 26, 2011 at 06:08 PM ET

euro needs to be devalued through easing from ECB , maybe it's a good idea to short EUR/GBP and play out this weakness

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.