The case for buying the dollar… and selling the euro

In the battle of the currencies, two are emerging as the more talked about – the euro and the dollar.  After the greenback has hit its lows against the euro some time last week, some are saying it might just be positioned for a comeback.  Prior to the fall of investment banking giant Lehman Brothers, the euro bought more than $1.40 before the financial crisis has brought it down to its lows of $1.2502 in late November and just about retested it during March lows.

As the global economy displayed signs of recovery from its lows March via better than expected economic data as well as earnings beating analyst expectations, the dollar has lost some steam as risk appetite once again came back to the markets.  Investors, seeking riskier assets, have opted for the euro.  But upon hitting $1.4434 per euro last week, and the US economy expected to pick up the pieces faster than Europe, investors and analysts alike are predicting a greenback comeback. We can look at two supporting articles on the matter.

A report from Bloomberg reads:

The euro fell 1.1 percent on Aug. 7 as the MSCI World Index of stocks rose 0.4 percent, the second time in a month the currency failed to appreciate as it did earlier this year when equities gained. For BNP Paribas SA, which correctly forecast in May that it would rise to $1.40 from $1.3390, the breakdown means the euro’s strength is ebbing. Goldman Sachs Group Inc., which earned more than $100 million from trading for a record 46 days last quarter, says the euro is going to “stall.”

Apart from that, a comparison of separate economic data may point to a better situation in the United States.

Europe’s economy may prove the euro’s biggest hurdle. Retail sales in Germany, Europe’s largest economy, unexpectedly dropped for a second month in June, slipping 1.8 percent. European producer prices tumbled 6.6 percent, the most in at least 28 years. In the U.S., sales at retailers rose 0.6 percent from May, the biggest gain since January, while the Labor Department’s producer-price index increased 1.8 percent, twice as much as anticipated.

More here.

Backing up the bullish stance on the dollar is Marc Chandler from Brown Brothers Harriman, who cited three things one could look for that might serve as their go signal to go back into the dollar.

First, watch interest rate differentials, especially short-term interest rate differentials… Second, the pattern by which the dollar appears to be better amid bad new[s] and does worse as the news improves, has to break… Third look for potential reversal chart patterns and divergences to help identify low risk entry time and levels to establish long dollar positions or reduce short dollar hedges.

At the moment, Treasury yields for short-term securities are below that of European securities such as the bund, Eurodollar and/or Euribor.  Chandler points out that when we see the yields reverse, indicating a flee from these safer assets, the dollar could ride with the bulls and manage to climb up against other major currencies, such as the euro.

Looking at the most recent rally staged, the dollar has unsurprisingly lost ground against the euro.  While the currency of the Union has already spiked up versus the American currency, the US economy is preparing for a comeback in the third quarter with some people expecting a growth.  Most recent trading of the European currency shows that it might have already reached its peak last week when it fetched $1.4447.  “Breaking the pattern” is what we might see. Defying conventional belief, further strength in the US economy could take with it higher the value of the dollar.

Completing the analysis is a look at the charts.  Chandler writes:

Specifically, a number of these technical tools suggest the euro could rise to $1.46-$1.4850. This of course is close to what would seem to be psychologically important level of $1.50. Drawing on similar tools, the $1.73-$1.75 area is a reasonable for sterling. As these areas are entered, one should be sensitive to the emergence of reversal patterns or price action that suggests exhaustion, including bearish divergence in momentum indicators.

Apart from a comparison with the euro, he also looked at the dollar’s performance against the Japanese yen. After failing to hit new lows following the lowest level it has seen in December, when it hit ¥88 to a dollar,  the latter is positioned to emerge from that bottom. And the move is up.

Read Chandler’s entire report here (PDF).

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