Monday, May 23, 2011 7:35:46 PM
With the currency on Monday dipping below $1.40 for the first time since March, a worsening sovereign-debt crisis, a faltering global economy and a general positioning reversal in foreign-exchange markets may conspire to bring the European currency down.
The next stop for the euro is more likely $1.35 than $1.45, some analysts said. At very least, few market participants are ready to say this is a buying opportunity, unlike what similar pullbacks induced earlier in the year.
"I could see it easily trading down to $1.35 this week," said Andrew Wilkinson, senior market analyst at Interactive Brokers in Greenwich, Conn. The common currency was most recently at $1.4051, according to EBS via CQG. It appears to have found some support around $1.40, which is just above the 100-day moving average.
Jens Nordvig, head of G-10 foreign-exchange strategy at Nomura Securities in New York, said trend-following hedge funds "definitely got caught" by the euro's quick fall. Most have squared their positions now, but some "still have some euro longs that could get washed out."
Nordvig said $1.30 probably isn't a possibility for the short term, but the euro is facing some additional downward pressure.
A further drop could come as more hedge funds and speculative investors unwind pro-euro bets. These have been cut rapidly, according to CFTC data. Long euro positions fell to $7.4 billion as of May 17, down from $18.4 billion two weeks earlier and have probably shrunk further.
Win Thin, global head of emerging-markets strategy at Brown Brothers Harriman in New York, noted that Asian reserve managers were buying the euro earlier this year as it was quickly rising and thus got caught on the wrong end of the common currency's recent retreat.
Analysts said there is no rush for investors to jump back into the market right now, even with levels well off their peaks for the year. This is because the negative euro news continues to pile up without an end in sight.
"We're turning back the clock a whole year and nothing's changed," Interactive Brokers Wilkinson said. The same major problems that plagued the euro last spring are back at the forefront this spring.
Sovereign-debt issues are the biggest worry for traders right now. Greece looks as if it needs a debt restructuring to avoid default and euro-zone leaders appear ready to negotiate such a deal. But the European Central Bank has said it might not accept Greek debt as collateral if such a move occurs, putting a re-write of the debt in doubt.
A restructuring for Greece, on which Fitch Ratings cut its rating by three notches Friday, could push Ireland and Portugal to ask for more favorable terms on their bailouts as well, analysts said. Such a move throws more uncertainty into the situation.
The debt crisis is showing signs of spreading as well. Spain, Italy and Belgium are now in focus after local Spanish elections over the weekend struck a blow to the ruling party and possibly its ability to cut budget deficits, while outlooks on Italian and Belgian debt were cut by Standard & Poor's and Fitch, respectively.
"Can they ring-fence Spain and Italy" to help avoid debt problems exploding in those countries and forcing them to be bailed out as well still remains a big question, said BBH's Thin. Europe is "on a knife edge right now," Thin added.
The euro is also being hurt by weakening economic data around the globe, which has tamped down expectations for worldwide growth. China's purchasing-managers index hit a 10-month low as growth slows in that country. A reading on the euro zone's private sector hit a seven-month low, led by a slowdown in manufacturing.
If data continue to disappoint, it could reduce expectations for ECB raising rates multiple times during the rest of the year as has been market participants' assumption in recent months. The widening interest-rate differential between Europe's central bank and the U.S. Federal Reserve had been the primary reason for the euro's big rally during most of the year.
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