Euro-Dollar Update

My piece from last Friday suggested medium term investors begin cutting short dollar exposure. We identified three factors that should be tracked (moving averages, risk-reversal, and interest rate differentials).

1. The 5-day moving average of the euro is still poised to fall below the 20-day in the coming days. Sterling's moving averages turned late last week and the Swiss franc's turned at the start of this week. The Australian dollar's averages and the Dollar Index (DXY) averages are also about to cross. The cascading effect where all the moving averages in different sequence is not unusual as is consistent with our understanding of bottoms and tops being processes, they are carved out rather than precise moment. Other technical indictors (e.g. trend line violations, chart patterns, momentum) also warn of heightened risk of a dollar recovery after its recent slide.

2. The market's demand for euro puts last year around this time boost our confidence of a pending euro decline. Despite the euro's rally in recent weeks, the market still was willing to pay a (diminishing)premium for euro puts over calls. We thought a rise in that premium in the 3-month tenors would further indicate that medium terms euro longs were getting nervous. That premium today is the largest in more than a month.

3. We have found over the past year or so, the euro tends to track the US-German 2-year spread. That spread made a low for the move last Friday near 65 bp in favor of Germany. The spread has narrowed ever so slightly, but not very convincingly yet. Given that the US 2-year is anchored by overnight US rates, it is not surprising that the widening of interest rates in the US favor is happening first at the intermediate and long-end of the yield curve. US interest rates are rising and the entire US coupon curve has risen relative to Japan's and this may be contributing to the dollar yen getting slightly better traction.
Euro-Dollar Update Euro-Dollar Update Reviewed by Marc Chandler on October 27, 2010 Rating: 5
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