In last month’s update [see: Update on EURUSD Dec, 3, 2014] we noted that it was approaching an important level of support: the purple .886 that intersected with a trend line connecting the previous three lows. It was the perfect setup for a bounce if Draghi and friends didn’t come through with the massive quantitative easing they’d been threatening for the past couple of years.
We put a target on the white .618 Fib level just in case they finally did it. As everyone knows by now, they did it [see, well: They Did It.]
Guess where EURUSD ended up?
For anyone trying to relate the move to stocks, the picture is less than crystal clear. While there has been a strong correlation between SPX (below, in purple) and the euro, that correlation broke down in May 2014, when stocks soared higher in lock step with USDJPY.
(1) could EURUSD bounce significantly here, in the wake of the QE announcement?
(2) what are the ramifications for stocks?
continued for members…As to the first question, yes. The level of anticipation leading up to Jan 22’s announcement was extremely high — witness the front-running that took the pair from 1.22 to 1.12 in under a month. Having sold short on the rumor, it wouldn’t be surprising to see speculators and hedgers covering on the news.
The degree of any technical bounce is a bit tricky. It would take a lot of short covering to effect a meaningful retracement. After all, the ECB is officially trashing the euro to the tune of 1 trillion bucks.
The widely held expectation is that the Fed will “soon” be raising US interest rates, and therefore strengthening the USD — a viewpoint we don’t share, by the way. If we’re right, and US rates remain low or trend even lower, this will put pressure on the dollar and, in return, strengthen EURUSD.
So, don’t be surprised to see some tension between the two forces, and more sideways movement for the pair. Our next downside target of .9898 doesn’t look to arrive until later in the year — possibly October.
As to the ramification for stocks, we believe there’s a good chance of the yen carry trade winding down and the euro taking its place. USDJPY still hasn’t strengthened after reversing at the important 120.11 Fib level. If our expectation of further declines to come plays out, then stocks will need a new vehicle.
The basic concept, readers will recall, is to borrow in euros, invest in US equities or higher interest rate securities, and repay the borrowings at a discount after the euro has declined even further. With euro zone interest rates as low as they are, all that’s needed is a continually plunging currency to lock up some nice rates of return.
Japan was making more noise yesterday about expanding their easing. But, I think it was just an effort to keep the USDJPY pegged in the 115-120 range which, while it will do no harm to carry trade investors, won’t really benefit them. We’ll find out soon enough.
We’ll revisit EURUSD after the dust settles. But, in the meantime, keep an eye on this critical support here at 1.1210.