Euro summits tend to follow clear patterns

GOING into tomorrow’s European summit, there seems to be an air of optimism – even excitement. With positive chatter, you might dare to hope that this summit will be the one where Europe’s politicians finally deliver.

This week, confidence has come from economic data showing Eurozone inflation to be stable at 2.6 per cent, as well as an improvement of German investor sentiment, which rose for the second consecutive month.

The tone in Germany is also changing. It is now prepared to accept a “precautionary credit line” (PCL – yet another acronym) for Spain, which is a veiled way of showing support for a bailout. This is contrary to what some leading politicians have suggested.

But euro-dollar appreciated the comments. Yesterday the currency pair was trading above $1.3050 – previously a key resistance level. The single currency was also up against sterling and the yen. Chris Vecchio of FXCM says that “if it is time for the euro to move forward, it is this week”.

Spain needs to be careful about playing this game. After the announcement of outright monetary transactions, its yields stabilised below 6 per cent as traders saw a credible safety net. Cheaper funding costs gave Spain leeway to put off requesting a bailout. The latest talk is that PCLs will have the same effect: apparently Spain was considering requesting help, but there was still not unanimous backing within its government.

This is where sentiment departs from reality. Recently Standard & Poor’s downgraded Spain’s rating by two notches, and downgraded 15 of its banks, saying “the sovereign downgrade has direct negative rating implications on those banks”. The upshot is that the government must rectify its finances; that is the requisite precursor to long-term stability in Spain, particularly for its finance sector.

If Spain requests a bailout, it is difficult to see how much further up the euro may go. The target to look towards is $1.3175, according to Vecchio, and if that level is breached, then the $1.33 mark will be the next target.

But there are doubts whether the euro has enough strength to move to these levels. Angus Campbell of Capital Spreads says that “recent euro rallies have been met with sell-offs, and sell-offs have been met with rallies,” as we have traded within a range since early September. Kathleen Brooks of is “slightly wary about a move higher in euro-dollar and believes that strength will be sold into.”

The market also wants to see development on Greece’s next bailout tranche, as well as a Eurozone banking union. Greek Prime Minister Antonis Samaras was confident that the country would receive its next bailout tranche, declaring that Greece is “in the last stretch”. It is a bold claim, but one he would not have dared make earlier in the year. Nothing definitive can be expected on the issue of banking union. It is a vastly complex issue and it will take time to arrive at an agreement (or disagreement).

So traders hope to see progress from Europe’s politicians on three fronts. This is slightly concerning: when, in recent times, have the Eurozone’s politicians fully and convincingly delivered on one front, let alone three? “I wouldn’t build up too much hope,” says Campbell.

Given these issues, currency traders need to manage their risk. Neil Looker of City Index thinks that traders may get more “bang for their buck” by looking to the downside. “Negative news coming from the Eurozone may pull the currency down to $1.2820.”

Eurozone summits have typically followed a trend: rallies leading up to the summit, and sell-offs preceding them. Whether this summit will be different remains to be seen. But if the trend is really your friend, then you should look to protect your downside.