I view the Euro as a broken currency. The common currency continues to inflict undue hardship on the southern European countries, locking them in to an unsuitable monetary and fiscal regime that is fanning the flames of a current (and future) populist backlash. Yet, the actual value of the Euro has been remarkably stable in 2013.
In fact, last week, speculative EUR/USD positioning reached its highest level in more than two years, courtesy of the ShortSideofLong blog:
It’s as if the European crisis has been totally resolved, and all of Europe is rejoicing in the green valleys and lush mountain pastures of the Sound of Music.
The European sovereign issues are deeply structural, due to longstanding imbalances that finally came to the fore a few years ago. The lack of capital in the banking system, the structural imbalances between the North and the South, and the entrenched rigidity of certain sectors are all factors. But the effect of these issues is not just economic. The political, economic, and social ramifications will take many more years to play out.
I’m a long-term bear on the Euro for all those reasons. The currency has been supported by the woes of other competitors (most notably, large QE by the U.S. and Japan), but for all the problems in America, I’d rather own a dollar than a Euro any day of the week. However, shorting the Euro has not been a fruitful enterprise for 2 years now. For the first time in a long time though, optimism reigns with regards to the Euro, perhaps as much due to the passage of time (hey bro, we haven’t tried long Euro in years, maybe it’s worth a shot) than to any pivotal fundamental reason.
I still hold my FXE trade structure from last month. My bearish bias in the short to intermediate term rests mainly on 2 tenets:
1) Though tapering is still not imminent, traders are itching to get out of the dovish Fed trades at the first hint of change in Fed rhetoric. As a result, I anticipate the change in asset prices related to tapering will happen far before the actual event (which again, might result in no tapering when event time comes, but in the meantime, I do expect dollar tightening to be priced in)
2) Bearish dollar (and bullish Euro) has become crowded, right before the failed breakout that occurred in EUR/USD in the past couple weeks. Hence, trapped longs could keep the EUR/USD cross capped on the upside
Shorting the Euro over the past few years has been one of those trades that makes too much sense. Too much sense, since everyone was positioned, with no one left to sell. We might have finally reached the point where there are plenty of incremental sellers, no matter the news. That’s what I’m betting on.