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After very tight range trading, the hammer fell on EUR/USD: the pair made a sharp drop and eventually lost the 1.2945 line which was the previous trough seen in mid December.

The pair is now again in levels last seen in mid January. Update: Now 6 reasons are cited for this fall.

  1. Rumors of a downgrade: While S&P said its report on the euro-zone will be released only in January, other rating agencies could act earlier.
  2. ECB Balance Sheet Grows: This is the reason cited by some market participants. The sum of overnight funds parked with the European Central Bank has grown, showing distrust among banks. The massive LTRO operation made last week enlarged the balance sheet.
  3. Peripheral bonds on the rise: While Italy had a successful bond auction, the drop in yields lasted only a short while. Yields are at the magical 7% number once again.
  4. End of year flows: Big funds might be adjusting their portfolios on the last days of 2011 and this might cause the movements.
  5. Low trading volume: The holiday week in most of the Western world sees many market participants out on holidays. This could explain the severity of the falls.
  6. Oversold conditions waned off: CFTC numbers released before Christmas showed extreme short euro positions as of last Tuesday. When everybody’s short, nobody is left to sell. Well, after a week, the picture probably balanced, and there are new sellers.

EUR/USD is currently at 1.2915, after hesitating around 1.2945. The next stop is the year-to-date low of 1.2873. Will the pair record a new year-to-date low just before year end?

For more on the euro, see the EUR/USD forecast.

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