Euro Decouples from Recent Correlations, Lags Majors as U.S. Dollar Slides

Fundamental Headlines

• Home Prices in 20 U.S. Cities Decline More Than Forecast – Bloomberg

• King Says U.K. Must Have Contingency Plan as Euro Risks Rise – Bloomberg

• In Euro-zone Crisis, Companies Plan for the Unthinkable – Reuters

• S&P May Cut France Rating Outlook – Reuters

• European Nations Pressure Own Banks for Loans – WSJ

European Session Summary

After Monday’s quizzical rally, the trend appeared to be broken in the overnight Tuesday. Midway through Asian, markets were exhibiting signs of “risk-off” and the implications were that gains by higher yielding currencies and risk-correlated assets were to be short-lived. Credit markets suggested this, and the lack of conviction behind the EUR/USD’s move higher confirmed this notion. Yet, at the start of trading in New York on Tuesday, the U.S. Dollar was the worst performing currency across the board – what boosted sentiment in European trade?

Looking towards Europe – really the only geopolitical zone worth paying attention to these days – bond auctions in the periphery countries were “better-than-expected.” I phrase that sentence as such considering that the sovereign bond markets suggest financial conditions continue to erode – Italian borrowing costs are near record highs and remain above 7 percent. Yet, the fact that investors continue to be willing to fund the Euro-zone periphery is a welcomed development following last week’s poor German auction. As such, as European trade opened on Tuesday, higher yielding currencies and risk-correlated assets caught a bid, dropping the U.S. Dollar to its lowest level in a week.

EUR/USD 5-minute Chart: November 29, 2011

Charts created using Strategy Trader– Prepared by Christopher Vecchio

The Australian Dollar was once again the top performer in the overnight, climbing back above parity and even flirting with the 1.0100 figure – although the pair traded at 0.9995 at the time this report was written. The EUR/USD continued to hold above the 1.3300 level, even after briefly rallying to as high as 1.3440 in trade this morning. The Euro’s underwhelming performance relative to its peers raises the question: why are market participants holding back from sustaining a higher bid for the EUR/USD?

Presented above is a graph comparing the relative performance of the AUD/USD, EUR/USD and S&P 500 Futures from the close of the U.S. session on Friday (18:00 GMT) to pre-market levels today (13:45 GMT). Over said time frame, both the AUD/USD and S&P 500 Futures were over 3 percent higher (with the latter nearly 4 percent higher); the EUR/USD gained under 1 percent during this period. Considering markets are moving on two themes – the Euro-zone crisis and global growth prospects – it is odd that the EUR/USD has decoupled from higher yielding currencies (AUD/USD) and risk-correlated assets (S&P 500 Futures).

It is of my belief that the markets are slowly pricing in the end of the Euro in its current form. Having held this belief for some time, this appears to be coming to fruition as evidenced by the recent rally: market participants are unwilling to bid the EUR/USD as liquidity concerns remain elevated on the possibility of a major negative event coming out of Europe. Or, no one wants to be “caught holding the bag.”

This “cautiously optimistic” view on markets has led the Euro higher against the U.S. Dollar; though it is clear that its upside is capped. Barring major structural changes that support the long-term health of the Euro, it is likely that the EUR/USD pair will lag its counterparts’ rallies going forward.

24-Hour Price Action

Key Levels: 13:50 GMT

Thus far, on Tuesday, the Dow Jones FXCM Dollar Index is much lower, trading at 9961.42, at the time this report was written, after opening at 10001.21. The index has traded mostly lower, with the high at 10018.67 and the low at 9900.67.

--- Written by Christopher Vecchio, Currency Analyst

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