EUR/USD Weekly Outlook 8/17 thru 8/21 2008

Once again we have another interesting week before us and that could be potentially explosive for the EUR/USD with a high probability of seeing the euro make a sixth straight week of extended losses against the dollar.

There is an intense amount of risk on the euro and very little risk on the dollar this week. The factors I’m looking at and will most focus on this week to determine how I’m going to trade the EUR/USD will be: fundamentals, moves in commodities and bond yields, equities, and verbal manipulation from central bankers and other market players, and geo-political happenings.

Fundamentals:

This week is very light on USD data and heavily weighted with euro data. Where the euro falls into fundamental risk is the fact the data on the books are centered on growth (PMI, Industrial Orders), economic sentiment (ZEW), and GDP correlated data (Current Account, Trade Balance).

I think some of the forecasters and economic are a little overzealous with their predictions for this week’s euro data. I’ve not completed my normal fundamental research for the entire week but based on some preliminary data collection I’m overall bearish on this week’s euro data.

Obviously if we do get some strong upside prints on the growth data this will give the euro a desperately needed boost and should serve to halt the slide for the time being or at least slow it down. ZEW is going to be one of the real keys this week to whether or not the euro takes another beating at the hands of the fundamentals. Keep your eye on that data.

Fundamentally speaking, there is absolutely some risk on the dollar. First with the Building Permits and Housing Starts data… housing has been one of the biggest drags on the dollar. Should the housing data show continued weakness I believe this could take some of the thunder away from the dollar bulls.

Of course, we get speeches from Fed Bernanke and Fisher this week. Fisher will likely come out with his hawkish guns blazing and it wouldn’t surprise me at all to see the market react favorably to what he has to say. Bernanke is the real wild card. This will be Bernanke’s first speech since the dollar became an overnight sensation. What I’m convinced of is that he’ll use the opportunity to manipulate the markets.

My gut tells me if he does play the verbal manipulation game that he’ll say something to cool the rapidly appreciating dollar. I can’t imagine Bernanke is too thrilled about the dollar being the hottest new rising star in the global markets. It’s not healthy for the U.S. economy and under these economic conditions should do damage to factors that have already been set in motion to try and heal the economy.

A stronger dollar is going to hurt U.S. exports which are a key area the economy has depended on to stay alive. It will also negatively impact the Current Account and Trade Balance. Our Trade Balance didn’t really gain a whole lot of ground even when the dollar was at its weakest.

In a matter of just six or so weeks the dollar has gained 800+ points on the euro and has broken key resistance levels on the USD Index. The U.S. economy really cannot afford to see the dollar move up much higher on the USD Index. It’s getting into dangerously high territories. So, Bernanke has a lot of reasons to talk the dollar down from the pedestal the market has put it on.

Commodities:

One thing that is straightforward and simple: the euro will not stop falling if oil and gold keep falling. If you did nothing more than watch the euro’s real-time price action and watch gold and crude move in real-time you should have no problems making money this week.

For example, suppose you see crude start falling, there’s a very high probability the euro is going to follow it, same with gold. There is one market correlated variable that I believe could serve to stop the dollar’s gains – bond yields. Throughout the dollar’s rise to stardom bond yields have been unable to make any strong gains. The 10-year is sitting comfortably below 4%. Mortgage rates are rising and bond yields are not. The dollar is rising and bond yields are not.

Is the bond market giving us some clues? I believe so. I think the bond could be telling us this whole idea about the Fed raising rates in the fall and winter is a bunch of crap and they aren’t buying into the Fed hype. I’ve been a euro bear for the past few months but this doesn’t mean I’m a dollar bull. Not even close.

How much more can the dollar gain if U.S. bond yields stay at degraded levels? Not much more in my view. We need to watch how bond yields behave this week as these observations could yield more clues to help us trade smart and profitably.

ESF:

One of the “theories” going around the markets is that the Fed intervened to save the dollar from falling further on the USD Index and they used the Treasury’s Exchange Stabilization Fund (ESF) to carry out this intervention. I don’t really have an opinion on this one way or the other.

I can see it happening and it makes sense for them to do it. But what doesn’t make any sense is that they would rapidly appreciate the dollar and move it down to the 1.4700 level in just a matter of weeks. This makes no economic sense at all and will only complicate things for the Fed.

So, maybe they meant to stop the USD Index from going below 70 but going above 80 isn’t going to make Bernanke very happy along with U.S. exporters or oil companies. The ESF is a function of the Treasury and allows the central bank to directly intervene in the currency market to either appreciate or depreciate a currency in a drastically short period of time and to an extended degree. If the intervention theorists are right, the Fed would have likely used the Treasury’s ESF to price fix the dollar and manipulate the USD Index.

EUR/USD:

I’m going to keep shorting the crap out of this thing until price action, commodities, and fundamentals tell me otherwise. Traders that think it can’t go any lower, that’s its so-called “overbought” are fooling themselves if they truly believe the worst is over for the euro.

The euro will be at the mercy of its own fundamentals, crude, and gold. As I mentioned earlier, I do believe there is risk on the dollar this week. One of the biggest risks for the dollar is the Fed or ECB verbally intervening in the market.

Last week the ECB tried their best to talk up the euro but their words fell on deaf ears. Now, should the Fed come out with guns blazing to talk down the dollar, this might have more of a positive effect on the euro. The Fed could be more effective to help the euro than the ECB could. Also, should the euro’s growth data print surprisingly to the upside this would allow the ECB’s jawboning to carry more weight.

It’s very unlikely I’ll add any new positions before London opens. I need to see what happens when their liquidity hits the market as it will give me a much clearer view of where we may move on Monday. There’s not much data at all tomorrow and liquidity will still be in summer-session mode, so we need to prepare for some price swings.

Right now I have no plans of adding any new shorts under the 1.4705 level. I’m not seeing any reason to buy right now, but I don’t want to add any new shorts below that level for the time being.

I don’t have much more to add at this point. I think trading this week should be fairly straightforward and easy to figure out as long as you have your eyes on the right things and aren’t over-thinking things and over-complicating your trading.

Should all factors keep working against the euro and for the dollar I see the potential for the EUR/USD to drop 328 points this week – this is my “worst case scenario” for the EUR/USD based on my own numbers and forecasting of the market.

The potential for upside gains certainly exists this week but we all know what it’s going to take to make that happen and there will be a lot of resistance along the way up. On the upside I see current potential of a 142 point gain.

Be smart, do not overleverage, and please don’t make any knee-jerk trades. Allow the trade to come to you, wait for your price, and when you’re in doubt, stay out.