Despite a government and bank holiday in the US, forex traders are not getting to enjoy their Martin Luther King holiday. The markets continue to fluctuate like there is no right price, but rather continual flux as traders try to assess the future. Sometimes it seems that it is the function of the market to fool as many people as possible. The euro trade is a good example.
Trade in the EUR/USD began the year with the pair testing the 1.34 area. Then, with the uncertainty of the forthcoming debt auctions in Portugal, Spain, and Italy, the specs aggressively sold the euro. On the sell off to a low, briefly trading under 1.29, the latest COT report shows that speculators increased their short position in the euro from 25,674 contracts to 49,870 contracts. The closing price on 01 11 2011, the cut off date of this report, was about 1.2970.
The trading Gods are fickle, and the market quickly turned up, to again test the top side of the range at 1.34. Now in retrospect, we can give some of the reasons for the rally:
1. The auctions were pre arranged trades, as the European Central Banks, and other subsidized entities bought the debt. Despite higher yields, the apparent success of the auctions gave the euro a better tone. It was announced this morning that the Spanish will continue to avoid testing the auction market, and will resort to prearranged bank sales for their next debt roll over.
2. The Chinese voiced their support for the euro, and vowed to be buyers of newly issued euro debt. It is believed that the $2T+ inventory probably contains an ample supply of euros, as they have recently viewed the USD as a risky investment likely to depreciate in value. So, while this is euro supportive, it probably does not mean they will need to be euro buyers to purchase the debt. Further, Europe is a very big market for Chinese exports, and a collapse of the euro is not in China's interest.
3. Like the Chinese, the Japanese also have a big European market for their exports, and a weak euro would hurt this trade. With more than a little fanfare, the Japanese have announce they will buy 20% of the new Irish debt. What makes the Irish debt more appealing than the Greek, Portuguese, or Spanish debt is not known. According to comments in a Market Watch column by Lisa Twaronite she says:
"But some currency analysts — including J.P. Morgan’s Tohru Sasaki — believe that the Japanese government might have to buy euros after making its latest pledged contribution.
As of the end of last month, Japan’s foreign reserves were mostly held in foreign bonds and notes, with only about $13.8 billion in deposits — most of which are likely in U.S. dollars, not euros, Sasaki said in a note to clients Tuesday."
Last week, as the market was selling off, and the OI was rising, we asked the hypothetical question, who were the buyers? It now appears that the euro fix was on. The euro bankers, Chinese, Japanese, and their friends all had reasons, maybe some inside encouragement, to buy the euro. Did the central and other favored bankers engage in a little collusion to get some of the specs money?
Part of the rally during the last two sessions on Thursday and Friday was short covering, as the open interest in futures declined almost 20k contracts. It looks like specs took their lumps, as they exited the market.
Now where do we go? The euro bankers are busy trying to diffuse and defer their debt crises. It will probably take more than some new make up to transform the euro into a thing of beauty, but for the specs short the euro, their vision may be impaired. We are inclined to believe the short squeeze may not be over, so we will use a sell off to the 1.3175 area to try the long side of the euro versus the USD. Use appropriate money market stops, and watch for shifts in speculative sentiment.
Author: Ralph Shell - ForexRazor Analyst - Graduated from a small Ohio liberal arts college. Graduate studies in economics and history at Duke University. Ten years experience trading cash commodities in domestic and export markets. Former commodity analyst with Merrill Lynch in Chicago. Member of and floor trader at the Chicago Board of Trade for 18 years.