I understand the whole risk-on trade today. I am not fighting it, but have to say that out of all risky assets Euro rally makes no sense. It will be weighed down by austerity and recession. Why is it going up? Massive short positioning amongst the hedge funds is my answer. They are covering their shorts today I bet. Other than that, I see nothing else that would make EUR/USD go up this big. Lets look at fundamentals and technicals:
1. EZ growth is slowing to a crawling pace. EZ commission projects GDP to grow paltry 0.5% in 2012. This is a rounding error for annual GDP for that huge economy on any given day. EZ is in recession already, some top economists say.
2. ECB started to cut rates. What used to be a somewhat attractive and fairly safe spread between the euro and the dollar in the last few years, has now become more risky carry trade with EZ debt problems and now a lower spread due to 1st rate cut by ECB to reverse many prior hikes. Also ECB is buying more PIIGS bonds in the open market and is potentially getting ready to do it unsterilized (not mopping up the extra liquidity) to prevent Italy from becoming Greece, therefore further diluting the Euro's value.
3. Technicals do not look too hot. EUR/USD is in a well-defined downtrend from May 4th. It is in a consolidation mode, currently backtesting 50 dsma from below, to which it has been kind of glued the last week or so. All moving averages are pointing down. Unless EUR/USD breaks above 200 dsma and stays up there for more than 2 days, I would say sell all rallies - they are a gift.
Conclusion: I understand that market has to clean up some of the late shorts. It is undoubtedly painful process and will come to the end in a very near term. Those shorts who have a little more conviction and a better entry will win in the longer term. My idea is to keep selling into rallies with a target of 2011 low around 1.3150 or so.
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