Can European Leaders Restore Confidence?

Thursday, September 15, 2011

The Eurozone is in disarray due to the sovereign debt concerns, which have plagued the market for some time, and the banking crisis. Leaders are fighting to keep member states solvent and part of the EU, which has shaken investor confidence. The focus on avoiding the worst case scenario has distracted larger, healthier member states from focusing on economic growth. Technically, the Euro has broken out of a large wedge formation to the downside, after crossing through and remaining below the 1.4000 level. This bounce in prices does not appear to be a reversal pattern and could give bearish traders an opportunity to enter into bearish strategies more cheaply. Some traders may wish to consider exploring the idea of entering into a bear put spread, for example, buying the December Euro 1.35 put and selling the 1.30 put for a debit of 0.0150, or $1,875. The trade risks the initial cost and has a maximum profit of $4,375 if the Euro closes below 1.3000 at expiration.

Fundamentals

The Euro has had a pair of positive days, after falling 10 handles over a two-week period, but is this a sign of a reversal in the currency, or simply profit-taking? The currency has been battered as a result of the banking and sovereign debt crisis facing the continent. The recent actions to stave off sovereign debt defaults are seen as simply delaying the inevitable, and there is serious doubt as to whether the confederation of nations can remain intact down the road. Many traders and market observers do not believe that Greece can avoid a default and remain in the union, despite assurances from French President Sarkozy and German Chancellor Merkel. Even in the event that Greece is able to stay solvent and remain in the EU, the banking crisis threatens to derail economic growth, which may lead to further devaluation of the Euro. Thus far, large Eurozone banks have avoided a Lehman-like meltdown, but just as the US banking fiasco, there is no telling if this is just the tip of the iceberg.

Technical Notes

Turning to the chart, we see the December Euro dropping below the critical 1.4000 support level. This breakout can be seen as especially significant given the fact that the market has been consolidating in a wedge formation for the past four months. After the breakout, prices came down to test support near 1.3500 and then bounced. In addition to 1.3500, minor support comes in at 1.3385, and more significant support at 1.3000. The RSI indicator had been oversold, which may have helped to trigger some of the profit-taking the market has seen. It is also interesting to note that the 20-day momentum indicator is diverging from both price and RSI, which hints at near-term weakness.

Rob Kurzatkowski, Senior Commodity Analyst