FOREX

Euro Could Make a Major Bounce if the ECB Disappoints the Market

Witawat (Ed) Wijaranakula, Ph.D.
Thu Jan 15, 2015

The 10-year U.S. Treasury yield tumbled to 1.77% on Thursday before bouncing back and closed on Friday at 1.83%. The big decline in the 10-Year U.S. Treasury yield was in part due to the actions of the Swiss National Bank (SNB) to discontinue its exchange rate of 1.20 Swiss francs per euro as hedge funds got caught by surprise and scrambled to sell euros and bought gold and U.S. Treasuries as “Safe-Haven” trades. 

In the past several weeks, the market has already been questioning whether the highly anticipated QE announcement by ECB President Mario Draghi will come through at the next ECB policy meeting on January 22. Tokyo-based Nomura Holdings Inc. said last week that the euro could surge to U.S. $1.20 per euro if the ECB decides to introduce quantitative easing without any details.

Just a reminder, the 10-year U.S. Treasury yielded between 1.50% and 2.00% during the 2012 Greek government-debt crisis as the U.S. Dollar index surged to 92.4970, shy of the 52-week high at 92.5280, the highest reading since December 2005. 

Bloomberg reported that hedge funds have increased their bearish euro positions in the past four weeks to near record levels, the second highest since the peak in June 2012. It is not surprising that gold is gaining momentum in the face of a stronger dollar, as hedge funds are shorting the euro and buying gold in U.S. dollars, known as the currency gold trade.

The euro-dollar exchange rate surged on Monday to U.S. $1.1639 per euro, before pulling back and closed at U.S. $1.1605 per euro. If the euro-dollar exchange rate rebounds after the ECB meeting, the technical resistances are at U.S. $1.18 per euro and U.S. $1.2 per euro. If the euro-dollar exchange rate retests the U.S. $1.21 per euro resistance level, or 38.2% Fibonacci retracement, hedge funds could decide to liquidate their currency gold trade positions.

A word of caution from the Royal Bank of Scotland (RBS), who said last week that the ECB could launch an even larger-scale QE program than is expected…the ECB could double their current balance sheet from €2.2 trillion to €4.5 trillion, mainly through the bond purchases. 

In that case, the euro-dollar exchange rate could retest the support level of U.S. $1.14 per euro, or the 15-year trend line support. No one can tell what the hedge funds will do next. The hedge funds may decide to liquidate their currency gold trade positions to take profit, or they might hold on to their short positions.

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