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EUR Holds Steady, What are Traders Waiting for?

Last updated 1/16/2012 9:41 AM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

Based on the price action of the EUR/USD this morning, Standard & Poor's decision to slash the credit ratings of most Eurozone countries did not mean the end of the world for the euro.  However the big question is whether today's muted reaction is caused by the lack of market participants or a real lack of concern about actions by rating agencies.  U.S. markets are closed for Martin Luther King Jr. day which means that a large number of traders are off their desks enjoying the long weekend with their families.  It would be easy to blame the resilience of the EUR on thin trading but Europe rarely needs the U.S. to get things going these days.  More times than not, we have seen big swings in Europe and quieter trading in the U.S.  London is the hub for FX trading and if the European traders wanted to, they could easily drive the EUR/USD below 1.25.  In fact, EUR/USD came under heavy selling during the Asian trading session and rallied on buying in Europe.  As last week's CFTC data showed, positioning in the EUR/USD is at very extreme levels which implies we are seeing a bit of short covering today.  Even though S&P made their announcement official after the equity and FX markets closed, there was talk of downgrades throughout the day giving many traders the opportunity to bailout of the EUR/USD on Friday.  

The fact that the EUR/USD is not trading on the 1.25 handle this morning is a bit surprising but we continue to believe that it should only be a matter of time before the currency pair breaks lower.  Moody's and Fitch will have no choice but to actively review their own ratings of France, Italy, Spain and other Eurozone countries.  If either rating agency follows in S&P footsteps, the pressure will increase on the EUR.  More importantly, all eyes are on the EFSF rating.  The rating of the France and EFSF are practically joined at the hip but it is not automatic which means that S&P needs to make the conscious decision to slash the fund's ratings.  We believe that it a lower rating for the EFSF is unavoidable especially since S&P previously said they could lower its rating by up to 2 notches. The only way to avoid a downgrade would be if the Germans committed more funds to the EFSF, which is unlikely. A downgrade of the EFSF would mean a higher borrowing cost for the facility which would undoubtedly be passed onto trouble nations, making it even more difficult for them to meet their financing needs – a slippery slope that the Europeans will have to contain quickly. The EUR should have a much more significant reaction to a downgrade of France than the USD had to a downgrade of the U.S. because of severity of the sovereign debt crisis and the global ramifications. European bonds are not the same as U.S. Treasuries – Treasuries are often perceived as some of the safest investments in the world but investors do not feel the same about German and French bonds.  The European Summit is in just a few weeks and the consequences of the downgrade could be a big topic of discussion.  The ECB will be hard pressed to reconsider their optimistic outlook and plans to increase monetary stimulus.  1.25 is the key level in the EUR/USD but 1.2625 is near term support.  

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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.