Political ineptitude is driving euro-dollar

THE string of announcements yesterday provided a snapshot of the failings of politicians and committees on either side of the Atlantic to come up with any form of solution to their respective debt woes.

We saw some short-term euro-dollar moves off the news that the IMF had approved changes to credit line structures designed to provide funds for struggling member nations. But markets soon shrugged off this news as flaws in the proposals became quickly apparent – with Europe unable to bail itself out, the lion’s share of the facility would have to be underwritten by the US, something that is unlikely to be approved by Congress.
The US congressional supercommittee also achieved the completely expected by failing to reach an agreement in talks aimed at reducing the unsustainable US budget deficit.

More was expected from the FOMC minutes, but when they were leaked 30 minutes early they didn’t contain anything to rock the dollar. There was talk of an inflationary Fed policy linked to NGDP, but the consensus seems to be that the current bad FOMC policy is better than any alternatives: “The discussion in the FOMC minutes suggests that it won’t take much of an excuse for the Fed to swing into action again and were therefore taken as dovish by the market. But are we really surprised by this?” says John Hardy, consultant FX strategist for Saxo Bank. He says that as long as Bernanke remains in the helicopter’s driving seat he will pursue the cash drop approach with unwavering academic zeal whenever conditions warrant until the Fed chairman either finishes his term or is removed from office.

According Colin Cieszynski, market analyst for CMC Markets, with the US maintaining its current monetary policy, euro-dollar trading is more likely to be impacted by developments in Europe in the coming weeks than by the US side. And there is no lack of bad news on the horizon with the potential to shift the pair. It has been reported that France’s AAA rating is under threat. But with its 5 year CDS trading at 242bps, you have to ask whether a downgrade would make any difference to anything except short term market sentiment. It certainly isn’t being treated as a AAA nation by the debt markets. More serious is the continuing surge of Italian and Spanish yields, up and beyond what is seen as the point of no return.

So how should traders approach euro-dollar going forward?

For those trading intraday in euro-dollar this week there have been, as it says in the Apostle’s Creed, the quick and the dead. With big swings on the back of market sentiment rather than solid fundamentals, it has been easy to get caught out if you are trading short term. However, as FXCM analyst Alejandro Zambrano points out, with most traders already short the euro, euro-dollar has found some interday support. “Not even the strong correlation between stock markets and euro-dollar has been able to push the pair lower as markets like the FTSE look likely to trade to their yearly lows in the coming weeks,” says Zambrano.

Should ECB buying up of Club Med debt continue to achieve very little long term traction, Zambrano points to a euro-dollar target of $1.3150, declining in the long term to $1.2500.

But as David Rodriguez, quantitative strategist at DailyFX points out, if there is an upside move in the euro, we will see the equivalent of somebody yelling “fire” in the proverbial movie theatre: “Usually we see that the downside is faster than the upswing, but in this case we will see a ‘melt up’ with panic on the top side. There will be a squeeze as everybody tries to get out of their position.”

Traders should be careful not to get stuck in the burning room.