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EUR Hits New 7 Wk Lows, December Forex Seasonality

Last updated 11/25/2011 9:28 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

Another abysmal bond auction in Europe has driven the euro to a fresh 7 week low against the U.S. dollar.  This morning, Italy sold six month bills at a record yield of 6.5 percent and zero coupon bonds at an average yield of 7.814 percent.   In response, 10 year Italian bond yields rose high of 7.322 percent, a painfully expensive level for Italy to borrow for 2 let alone 10 years.  We have warned that one of the most immediate consequences of rapidly rising bond yields are downgrades by rating agencies and while American traders were off enjoying their holidays, Moody’s and Fitch took an axe to Portugal and Hungary’s sovereign debt ratings.  We have already seen how much damage lower ratings for smaller countries such as Greece, Portugal and Hungary can have on euro, a downgrade of Italy or France would surely drive the EUR/USD below 1.30.  What had once been only a possibility is now becoming a growing reality.  European officials need to act and act quickly if they want to prevent Spanish yields from rising to Italian levels and to save Italy from paying more than 8 percent to borrow.  Italian bond yields are moving into very dangerous territory and if nothing is done reverse the rise in borrowing costs, we could get fall into a vicious cycle where borrowing costs rise, triggering downgrades which then cause yields to increase further - all of which is bearish for the euro.  At this point, there is no major support in the EUR/USD until the October low of 1.3145.  Hopefully things will settle once the European markets close since the U.S. stock market is also wrapping up trading early today at 1:00pm ET.   

Unsurprisingly, continued uncertainty in the Eurozone has driven the dollar higher across the board.  With no U.S. economic data on the calendar, we want to take the opportunity to revisit one of our favorite topics – Seasonality.   If you have ever heard of a Santa Claus rally, you may know that traditionally December is one of the best months of the year for equities. U.S. stocks rallied 63 out of the last 83 years or 76 percent of the time. After this past week’s bloodbath, a recovery is desperately needed and for forex traders who know that equities and currencies have been moving in lockstep in recent months, a rally in equities will hopefully mean a rally in currencies.  Of course, seasonality can be overshadowed by many different factors and this year in particular, investors have the European sovereign debt crisis to contend with and the lack of progress going into yearend means there could still be further losses in equities and currencies.  Nonetheless, seasonality makes us aware of where the odds lie in case EU leaders manage to announce a year end deal that satisfies investors. EU leaders are gathering in Brussels in December to discuss ways to provide more support to the region and the recent increase in European bond yields puts additional pressure on European leaders to stabilize things quickly.  According to French President Sarkozy, an EU Treaty change is on the table and if the change is significant enough, it could send equities and currencies soaring.  Yet we have seen disappointment after disappointment from the Europeans which is why we are hesitant about relying too much on seasonality.  Nonetheless, for what I it is worth, here are the numbers. 

The first chart shows the performance of the S&P 500 over the past 10 years during the month of December. Equities rallied 7 out of the last 10 years and besides the sharp sell-off in 2002, the other declines did not exceed 1 percent.

The EUR/USD which traditionally has the strongest correlation with the S&P 500 fell 6 out of the last 10 years but aside from the sharp sell-off in 2009, the weakness of EUR/USD during other years was limited to 0.7 percent.

The strongest evidence of seasonality is actually in the NZD/USD, which appreciated in the month of December 8 out of the last 10 times. It would be 9 out of the last 10 times if we consider the nominal 0.19 percent drop in the NZD/USD in 2001 as nominal. 

For those that are curious, the seasonality bias in the other major currencies pairs are not strong. 

Trading Seasonality

The reason why we like to look at seasonality is because Technical Analysis is based on the idea that price patterns repeat themselves and seasonality is rooted in this very same concept.  Seasonality is defined as a pattern that occurs at given times within the calendar and throughout the year, there are a good number of cases of seasonality.  Seasonality does not work 100 percent of the time which is why trading seasonality blindly by buying the EUR/USD at the beginning of the month and selling it the end of the month is not necessarily the best thing to do.  The best way to incorporate seasonality into your forex trading is to simply be mindful of it. For example, it may be a better idea to look for opportunities to sell the dollar against currencies like the New Zealand dollar and Euro next month than to buy it. Seasonality helps us understand where the probabilities lie.

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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.