$1.32 Euro Under Construction

by Ashraf Laidi
Feb 3, 2010 17:02 | 116 Comments

We pointed out 2 weeks ago that the ongoing decline (weakening) of the once strong inverse correlation between equities and USD would lead to a scenario of prolonged US strength regardless of the evolving trend in equities. As the correlation weakened from a strong -0.94 in November to -0.26 in the 1st week of January, it enabled us to forecast further advances in the greenback irrespective of intraday or daily moves in equities. By taking the other side of the coin and using the daily relation between EURUSD and S&P500, the positive correlation has now fallen from +0.94 in November to a statistically insignificant +0.27 (9-month low).

And as the relationship between FX and equities fades away, the role of yield differentials is strongly back in play, especially for the high profile EURUSD rate. The chart below clearly shows the correlation between German & US 10 year yield spread and EURUSD at an 8-month high of +0.61. Such strong correlation implies that as US yields (now at 3.68%) further gain above their German counterparts (now at 3.22%), the USD dollar strengthens further against EUR, thereby dragging down EURUSD. As markets expect the ECB to maintain rates unchanged (no tightening) and more FOMC members to dissent against the stance of exceptionally low levels of fed funds rate for an extended period, the US yield foundation is expected to further work in favour of the USD against EUR. The $1.38 target issued in January remains intact with a 60% probability of seeing a $1.32 in March.

$1.32 Euro Under Construction - Correltneurstocksjan29 (Chart 1)

Deepening the analysis into the sovereign spread situation, it is worth noting a possible recurrence of a double-take, similar to that March 2009. The charts in the lower frame below represent the spreads of 10-year yields of selected Eurozone nations over that of Germany (considered the safest bond in the Eurozone). Greek 10 year yields soared to as high as 400 bps above those of Germany, while Portuguese and Spanish yields hit 129 bps and 0.98 bps respectively.

$1.32 Euro Under Construction - Eurvixsprdsfeb210 (Chart 2)

Although all of the spreads have now stabilized--partly due to EUs approval of Greeces debt plan, the risk for fresh jitters remain ample. The EU Commission said it was launching legal proceedings against Greece for unreliable fiscal statistics. As markets keep a close watch on Greece and its interaction with the Commission, the negative FX bias will remains specially that the EU has asked it to reduce its budget deficit to 3% of GDP by 2012 from above 12% today. The Commission will review Greece's progress on March 16, then on May 16,

While Greece and Portuguese debt are stealing the headlines, Spain's fiscal situation also merits focus. 4 months after it projected a 2009 deficit of 5.2% of GDP, Spain issued a new forecast of 11.4% of GDP. Not only data reliability is questionable, but so are any signs of any recovery. This week, Eurozone manufacturing PMI showed its fastest pace in reaching 52.4 in Jan, while Spains own PMI remained adrift in sub-50 territory at 45.3. With unemployment exceeding 4 million, the macroeconomic situation remains an obstacle to any austere fiscal policies.

Incorporating these dynamics with dissenting FOMC members and struggling global indices (have yet to regain their 55-day MAs), the US dollar faces prolonged upside ahead.

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Comments (Showing latest 10 of 116) View All Comments
kartitsch, Austria
Posts: 69
9 years ago
Mar 28, 2010 9:50

only sell

see my last posts on threads

S&P500 / VIX Ratio & USD LIBOR and
dubai, United Arab Emirates
Posts: 4
9 years ago
Mar 28, 2010 7:48
i have 10million euro position. what is your opinion. keep or sell
Posted Anonymously
9 years ago
Mar 24, 2010 20:23
1.40 because the euro is cheap! its not cheap at all on a historic basis. anyway, i think we should get some upwards retracement once we finally hit 1.32 but that shouldnt last long before the euro falls further. 1.20 is where i see a bottom for 2010
Ashraf Laidi
London, UK
Posts: 0
9 years ago
Mar 24, 2010 13:21
For those who say euro is going to 1.40, can you please tell us why. It's all about your arguments and not just the target.

Sydney, Australia
Posts: 348
9 years ago
Mar 24, 2010 9:19
euro will go down like no tomorrow
Tirana, Albania
Posts: 2
9 years ago
Mar 24, 2010 7:22
Someone will help Greece and we will see Euro above 1.4 this month.
Korea Sout
Posts: 67
9 years ago
Feb 22, 2010 9:14
all your opinion pippedoff, xaron, redstone thanks. ^!^;
bristol, UK
Posted Anonymously
9 years ago
Feb 22, 2010 7:41
possibly 140 before we start heading for 1.24.
Munich, Germany
Posts: 528
9 years ago
Feb 22, 2010 7:22
I tend to agree pippedoff, but I also think that we could see 1.39 first.
Posted Anonymously
9 years ago
Feb 22, 2010 7:11
@xaron-already had the 200 pip technical bounce in euro, led by 200 pip bid on eur/gbp/

The Italioan situation will now take over to sppok markets and euro lower. GOLDman has destroyed the countries and euro with it's greed in packaging the swaps for huge commissions so these countries could mask the truth and obtain financing at lower rates and cost than should have.