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Euro Feels Sense of Déjà vu as Troika Summit Could Decide Direction

Euro Feels Sense of Déjà vu as Troika Summit Could Decide Direction

David Rodriguez, Head of Product
Euro_Feels_Sense_of_Deja_vu_as_Troika_Summit_Could_Decide_Direction_body_Picture_5.png, Euro Feels Sense of Déjà vu as Troika Summit Could Decide Direction

Fundamental Forecast for the Euro: Neutral

An eventful week for Greece, Spain, and broader financial markets left traders scrambling for safety and pushed the Euro lower against the safe-haven US Dollar (ticker: USDOLLAR). It initially looked as though the Euro could trade higher as a positive result in Greek elections averted the real risk that Greece could immediately default on its debt. Yet the relief rally and sudden enthusiasm proved short lived, and the general Euro downtrend remains alive and well into the final week of June.

A relatively limited week of European economic event risk leaves trader focus squarely on further developments in Euro Zone fiscal and financial crises. Week after week we’re left with a sense of déjà vu; in theory the next big Euro moves could occur following yet another European summit on June 28-29. Yet anyone who’s waited for any real resolution out of the never-ending summits has been left squarely disappointed.

Instead we’ll track short-term moves in European bond markets as well as broader financial markets, and any major moves particularly in Spain and Italy could make the difference between a Euro relief rally and sharp tumbles. This past weekend’s Greek elections were the most significant event risk for European markets in quite some time. A victory for the far-left (Syriza) would likely have forced Greece into technical default in short order. Traders undoubtedly hedged against such a risk, and the post-elections Euro bounce was arguably a function of the fact that traders no longer needed short-term insurance against a Greek default—closing EUR-short positions.

Now what? A positive Greek result avoided the worst of the short-term risk, but sharp sell-offs in Spanish and Italian bond markets (rise in yields) underline that tensions and longer-term issues remain. Spain bond yields recently crossed above the often-cited “point of no return” at 7 percent—the level at which Greece, Ireland, and Portugal were forced to seek a fiscal bailout. An important reversal in bonds leaves the 10-year bond at a relatively modest 6.25%, but the mere volatility in yields warns of clear danger.

The announced bailout of Spain’s banks looks insufficient in light of recent price action, and markets clearly want the so-called Troika to do more for the Spanish government. The European Central Bank eased tensions somewhat when they relaxed collateral requirements for banks—particularly helpful in light of clear funding difficulties for Spain’s financial sector. Yet the fundamental fact remains that central government will have an especially difficult time financing fiscal deficits and bond redemptions. Who bails out Madrid?

Spanish funding stresses are obvious the longer-term trend and issues are clear, but as traders we mostly care about the timing of Euro moves. The EURUSD fell to fresh year-to-date lows amidst a sharp deterioration in market conditions through May, but the month of June has been far kinder. We are strong believers in seasonal tendencies in forex markets; currencies will quite often set monthly highs and lows at the beginning and end of each month. This happened exactly in May when the Euro topped on May 1 and traded consistently lower. It showed its strength once again as the pair set its year-to-date low on June 1 and has since traded higher. Based on pure seasonal tendencies, we see risks that the Euro could trade towards June highs near $1.2750 in the week ahead.

Can July bring another change and resumption in the broader downtrend? Certainly this would fit in well with the anticipated European summit on June 28-29. Yet we likewise see risks that the EURUSD could continue to consolidate/trade higher through the foreseeable future. Why? Large speculators recently hit their most bullish US Dollar and bearish Euro on record. Consolidation seems natural given such one-sided positioning, and it could create another frustrating week of trading as traders remain unsure of the next Euro moves.

- DR

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.