Weekly Strategy-Selling the Rebound in EUR/USD

Brian Dolan, Chief Currency Strategist

EUR/USD is in the process of correcting higher as excessive short EUR positioning is cut on signs of stabilizing Eurozone debt markets. Recent EU debt auctions have been successful in spite of the recent ratings downgrades, but with growth stagnant to negative growth prospects, we don’t think much of the underlying fundamental outlook has changed. Negotiations over the Greek debt swap are nearing a potentially successful conclusion, and this also appears to be bolstering short-term EUR sentiment, though we’re also skeptical that the reported 32-cent per EUR settlement classifies as a good result for Greek debt holders. Indeed, if that is the final agreement, we would expect to see EU banks report significant losses on the debt swap, possibly triggering payouts of credit default swaps and reigniting a European financial crisis. ECB 3-year lending to banks does potentially represent a more significant turning point in the never-ending debt crisis, so we can’t rule out that this is more than just a correction and may have more room to go. But with embattled EU countries’ (Italy, Spain and France) government debt yields still at elevated levels, we don’t think markets are fully convinced and our preference is to treat this as an opportunity to re-sell EUR/USD at better levels. We think the ECB will be cutting rates in the months ahead on the weak growth/receding inflation outlook, while the improving US outlook will delay the Fed from introducing a third round of asset purchases (QE3). In fact, we also view some of the USD weakness seen this week as markets pricing-in the potential for a QE3 announcement at next week’s FOMC meeting (Jan.25), which we think will be disappointed.
The strategy will be to sell 50% of a short EUR/USD position on strength to 1.3075 (just below the 50% retracement of the decline since early December) and the second 50% at 1.3190 (below the 61.8% retracement) for a short average rate of 1.3133. The stop loss will be on a daily close above the base of the daily Ichimoku cloud (currently 1.3298, but falls sharply next week to 1.3240/50) or if 1.3300 ever trades, for a potential risk of around 170 points. The take profit objective will be for a return to near recent lows in the 1.2630/80 area, but we would trail stops aggressively (50 pips) on weakness below 1.2800. An alternative strategy for those who think this is a bigger turning point in the EU crisis, buying pullbacks into the 1.2800/50 area, with a tight stop at 1.2750, could be an opportunity.
EUR/USD
Support
1.2875 21-day sma; broken daily trendline, now support
1.2800 Daily Tenkan line
1.2760 Converged 200-hr and 100-hr moving averages
Resistance
1.2976 38.2% retracement of 1.3550-1.2625 decline
1.3085 50% retracement of 1.3550-1.2625 decline
1.3245 Bottom of daily Ichimoku cloud

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