By
David Rodriguez, Quantitative Strategist
Fundamental Forecast for the Euro: Bearish
- Euro dragged lower by Spanish troubles
- Odds of an important Euro/US Dollar top grow as optimism fades
- EURUSD: What does multi-year low volatility measures mean for direction?
The Euro finished the week
almost exactly where it began, and traders expect extremely quiet price
action to continue through the days ahead. A relatively quiet week for
economic event risk leaves all eyes on the US Federal Reserve as traders
try to time the next jump in financial market volatility.
FX Options traders are
betting on the smallest 7-day Euro/US Dollar volatility in five years,
but what could force the slow-moving EURUSD pair out of its recent
trading range? A relatively empty European economic calendar leaves
little reason to expect the catalyst for a major break will come from
the continent. Across the Atlantic, however, the release of the minutes
from the most recent US Federal Open Market Committee meeting could stir
speculation for the US central bank’s next monetary policy moves.
Given heightened speculation surrounding the future of the Fed’s Quantitative Easing measures (QE3), all US Dollar pairs could see big swings
on surprises in FOMC minutes. Surprisingly strong US Nonfarm Payrolls
data for July tempered speculation that QE3 was imminent, and indeed the
official statement from the Fed’s most recent meeting showed little
change in stance. Yet Fed officials are most often more candid in their
assessments of economic risks and the likelihood of fresh policy action
in FOMC minutes. Any significant surprises could force the US Dollar
(ticker: USDOLLAR) to move in kind.
It is certainly tempting to claim that the Euro set a significant top at the $1.2440 mark and could break substantially lower in coming week. Yet we’re big believers in FX market seasonality, and the fact that the Euro/US Dollar continues to move in a progressively narrower trading range through August suggests we may need to wait until September for the next big moves.
In the meantime, our studies show low-volatility range trading strategies
have historically done well in quiet market conditions. For the Euro/US
dollar, this implies that any sharp rallies may be sold and noteworthy
declines bought. Similar data show that more aggressive breakout trading strategies—buying
high and selling higher or selling low to buy lower—have historically
done well as markets turn more volatile. Given that the Euro/US Dollar
remains in a fairly clear downtrend, we would favor selling a Euro break
lower. Before that happens, however, we will need to see a significant
jump in volatility expectations as that would increase the likelihood of
continuation lower.
September is still two weeks
away, but the coming month may promise larger currency swings on
several highly-anticipated dates on the calendar. For the Euro, all eyes
turn to the German Constitutional Court as it rules on the legality of
the European Stability Mechanism (ESM). If the ESM is deemed
unconstitutional according to German law, it would likely spell the end
of the critical bailout mechanism and arguably the most viable solution
to ongoing regional fiscal crises. September likewise promises a
contentious US Federal Reserve interest rate decision, and the coming
week’s FOMC minutes may go a long way in setting expectations for US
monetary policy.
It’s difficult to predict
exactly when currency markets could finally see volatility as trading
ranges fall to their lowest in five years. Given obvious macroeconomic
risks to the Euro Zone, we get the sense that the Euro itself is one
catalyst away from the next substantial move lower. Of course—timing is
the only thing that matters in trading. And frankly, timing a EURUSD
breakdown has eluded us for some time now. We see little choice but to
wait and see when the market proves willing to force big FX moves. We’ll
look to sell any significant Euro bounces and buy any sharp declines in
the interim. – DR
Source: www.dailyfx.com
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