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EUR/USD: Prime for a Breakout, Italy’s Parliamentary Vote Could be the Catalyst

Last updated 11/7/2011 10:33 AM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

The price action in the foreign exchange market today is a good example of what is in store for the rest of the week.  With no major U.S. economic reports on the calendar, headlines out of Europe has and will continue to be the number one driver of risk appetite.  This morning, reports that the European Investment Bank could lend support to the banking sector has helped the euro recover its losses against the U.S. dollar. This dramatic turn in the currency shows just how much demand there is for euros despite the potential risk of a blowup in Italy. Last week, short EUR/USD positions were cut significantly according to the CFTC and the resignation of Greek Prime Minister Papandreou will move the country forward in its path to receiving additional monetary support from its European neighbors.  Although Italian-German yield spreads have widened to record levels and the possibility of forced resignation of Italian Prime Minister Berlusconi is at its highest level ever, investors have not given up on buying euros because they know that Europe will not let Italy fail.  It can certainly be argued that Europe does not have the capacity to prevent a failure of Italy and this argument is absolutely true but if Europe takes the right steps, they can ease anxiety in the markets and encourage investors to stop selling Italian bonds or demanding higher yields for holding them, which would help drive borrowing costs lower.  There is no question that Italy is a much larger problem than Greece but this is a crisis of confidence which means that if the right steps are taken, confidence can be restored in Italy. This could involve a regime change that would initially cause volatility in the euro but eventually play a key role in stabilizing the currency.  As we saw in last night's reaction in the euro, news of Papandreou's resignation lifted the currency but it failed to hold onto its gains because the focus quickly shifted to Italy.  If Berlusconi loses the key Parliamentary vote tomorrow and is forced to step down, the EUR/USD could enjoy a relief rally because Berlusconi has been a larger part of the problem than the solution. 

Eurozone Finance Ministers are meeting to discuss the details of the EU debt deal announced in late October.  Any details on the mechanics of leveraging the European Financial Stability Facility could also lend support to the euro.  What have to understand that the Eurozone will do everything in their power to prevent Italy, the third largest country in the Eurozone from defaulting on its loans and that includes beefing up the EFSF quickly, lowering interest rates, dangling more carrots in front of China, raising funds through the IMF and anything else that they can come up with which will help to limit the downside in the euro.

Reality Check - Although it feels like there has been significant volatility in the EUR/USD after it broke down early last week, the pair's price action has actually been confined in a 300 pip range.  The tight consolidation suggests that the EUR/USD is prime for a breakout and the levels to watch are 1.3880 on the topside and 1.3608 on the downside.  These are the 5 day highs and lows in the currency pair and a break of either level would reinvigorate the trend.

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Comments (1)

Darkdoji

November 07, 2011 at 01:48 PM ET

Sure the Euro can fail big time - the reasons are structural and even more complex than say Japan and the USA that have demographics stacked against them. But true - all risk not just the Euro are holding their breath just now - even on an intraday basis the ADX across risk currencies and Yen crosses are primed to come out blazing, the question of course is which way Africa?

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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.