The euro has been gaining ground on the U.S. dollar amid speculation that the Federal Reserve may announce new quantitative easing measures. The dollar declined to $1.3639 per euro, the weakest level since April 15, 2010. If you are long the euro, you might want to let your position ride a bit longer. However, the euro is approaching some key resistance points, and Europe’s economy isn’t in better shape than the U.S. economy, so caution may be warranted.
Currency traders will be watching for any interest rate changes or statements from the Bank of England and European Central Bank, which both hold their regular policy meetings on October 7. The current rate in the U.K. stands at 0.50 percent, and in the Eurozone, at 1 percent. No changes are anticipated, but any statements in terms of asset purchases and/or the economy could be market-moving.
The story in currencies is tied probably even more so to the U.S., which has been struggling with a weak economy and lack of job growth. The September employment report will be released on October 8. A Bloomberg analyst survey shows the consensus forecast for a rise of 5,000 in non-farm payrolls, an improvement from a drop of 54,000 in August. The unemployment rate is anticipated to tick up to 9.7 percent.
Currency traders should understand the basic concept of purchasing power parity to determine whether a particular currency is over or undervalued. It’s a theory of long-term equilibrium between exchange rates. Two of the same items should cost roughly the same in two countries, even though the exchange rates fluctuate.
The graph below shows most currencies relative to the U.S. dollar are overvalued based on purchasing power parity. Note that the euro is more than 16 percent overvalued. Europe has some structural difficulties, and is perhaps in worse condition than the U.S. Keep in mind that purchasing power parity has some flaws, and is a long-term measure. It should not be used for short-term trading decisions, but is worth paying attention to.
Technical Factors
Many market technicians watch key support and resistance points. In the euro, traders were looking for a break of a prior high at $1.33 - $1.34, which was acting as resistance. You can see the breakout in the chart below, represented by the arrow. One of the next resistance levels is around $1.38 - $1.39.
The Moving Average Convergence/Divergence (MACD) is bullish, but the Relative Strength Index (RSI) is showing the market is nearing overbought conditions. The RSI is not too concerning.
One of the advanced technical tools that analysts watch are Fibonacci retracement levels. We won’t go into details about the mechanics of Fibonacci analysis, but what’s important to note is a level the two-thirds mark, or 61.8 percent, which is a key area technical traders pay attention to. It coincides with two tops, two prior resistance points, at $1.38 - $1.39. So it’s a good area to watch; traders might attempt to go short there and there would be some turbulence near there.
The 50-day moving average has crossed the 100-day moving average in the euro, which is also significant to note. The euro rallied a week after.
The euro also broke through the 200-day moving average, the next bullish sign. If the 50-day breaks through the 200-day, that would also send the markets further still. We don’t think there is much stopping the euro from moving to $1.38 – 1.39 from a technical perspective.
U.S. Dollar Index
Many traders like to follow the U.S. dollar index as a general barometer of the dollar versus other global currencies. It represents the dollar’s standing versus six major currencies, and the index hit an eight-month low on Wednesday, September 29. However, many don’t realize the index is heavily weighted towards the Euro, which about 60 percent. So if you have a view on the U.S. dollar and trade this index, you have to have a view on the European economy too. You are essentially playing the euro when you go long or short this index. There is also a 13 percent weighting in the yen, and smaller weightings in four other currencies. Whenever you are trading an index product, you will want to know what its components are.
In the U.S. dollar index, watch key support at 72. If this level is breached, the U.S. dollar could really have problems. This index is not very quick to move, so it could take some time. Both the Eurozone and U.S. economies are fundamentally flawed, so these moves aren’t going to be in a straight line. We are likely to see some back and forth, which will present traders with some great opportunities.
Drew Shaw is a Senior Market Strategist based in Lind-Waldock’s Toronto office, and is serving clients in Canada. If you would like to learn more about futures trading you can contact him at 877-840-5333, or via email at dshaw@lind-waldock.com.
Kyle McEwan is a Market Strategist based in Lind-Waldock’s Toronto office, and is serving clients in Canada. If you would like to learn more about futures trading, you can contact him at 877-840-5333 or via email at kmcewan@lind-waldock.com.
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