Lose-Lose Situation for the Euro

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If the ECB continues its policy regarding bond buying, the euro is set to fall. If it launches QE, it will likely follow the path of the greenback after QE2, with one specific euro cross set to gain.

Christopher Vecchio of DailyFX analyzes the current situation of the euro, the bright side for the pound in the aftermath of the EU Summit, the low likelihood of more US QE, how the Canadian dollar will react to rising tensions around Iran, and more in the interview below.

Christopher Vecchio is a currency analyst for DailyFX. With a background in political science and law, he focuses on the interrelationships between geopolitical events, macroeconomic trends, and market reactions. Also an active trader, Christopher monitors the markets around the clock. Expertise: News events, market reactions, an macro trends.Christopher Vecchio

1.     Mario Draghi disappointed many by refusing to scale up bond buying of peripheral debt. If this does eventually happen, how will it affect the euro? 

Going forward, now that bond buying is off the table in the immediate future, we look at the EUR/USD lower from here. If the ECB does print money, given what transpired with the U.S. Dollar after the Federal Reserve decided to inject the financial system with more U.S. Dollars (“quantitative easing round two”), the Euro will likely lose value. Both outcomes point towards a weaker Euro (a third scenario exists where the Euro strengthens: joint Eurobonds are issued, is off the table for now as Germany continues to oppose such an idea). For now, we look to stay short EUR/USD and sell on bounces higher. If the ECB does print, we turn to higher yielding currencies such as the New Zealand Dollar to sell the Euro against; short EUR/NZD would a favorable trade in the event the ECB decides to print.

2.     After the recent EU Summit, Britain and the other major European parties are more distanced from each other. How Will this political rift also be seen in currencies? Will the pound distance itself from the euro-zone’s troubles?

This is constructive for the British Pound in the short-term against the commodity currencies (the Aussie, the Kiwi, and the Loonie) and the European majors (the Euro and the Swiss Franc). Now that Britain is putting some distance between itself and its Euro, it will likely see capital flows exit the Euro and enter the Sterling; the British Pound happens to be the world’s oldest fiat currency. I think Monday’s capital rotation proved this – the Pound was the second best performing currency against the U.S. Dollar, just behind the Japanese Yen. While the British trade balance may suffer – the Euro-zone is the world’s largest single market – any distance, be it political or financial, that Britain can place in between itself and the Euro-zone will be beneficial going forward. I wouldn’t go as far as saying the Pound is achieving safe haven appeal given the country’s own debt issues (among the largest in the world), but given the stability of the Pound, it is more appealing than the Euro at present time.

3.     The FOMC seems to be balances between those wanting further easing action and those settling for the current measures or even opposing them. Do you think that the Fed will eventually launch new easing measures in early 2012? 

`If the Federal Reserve is to introduce another round of quantitative easing measures in the near-future, it will have to come after a shock to the American financial system or a substantial downturn in U.S. growth prospects. Given the recent uptick in U.S. data in the face of economic headwinds in Asia and a recessing Euro-zone, there’s not much out there that could legitimately justify the Fed enacting more easing. If the Federal Reserve sees an improving labor market, modest growth, and contained inflation, the Federal Open Market Committee will have little reason to announce another round of quantitative easing. Quantitative easing weighed heavily on the U.S. Dollar during its lifetime: the Dow Jones FXCM Dollar Index, an equal weighted basket of AUD/USD, EUR/USD, GBP/USD, and USD/JPY, fell 3.36 percent (5.04 percent annualized) during the second round of quantitative easing. If no further easing is on the table, as it is not at the present time, the U.S. Dollar looks to firm in the coming months.

4.     Tensions around Iran are higher in recent weeks. Do you think that an eruption of violence will boost the Canadian dollar as an exporter of oil? Or will it weaken as a “risk currency”?

I certainly believe that the Canadian Dollar has been supported in recent weeks by the tensions rising once again in the Middle East. In fact, since November 1 (concerns over Iran started to gather steam in early November) the Canadian Dollar is the second best performing currency against the U.S. Dollar, next to the Japanese Yen. This comes amid the other commodity currencies, the Australian Dollar and the New Zealand Dollar, declining over 3 percent, collectively, over the same time period. Given my belief that the tension with Iran will escalate to the brink of war, I expect the Canadian Dollar to be supported in the face of weakness on the back of increased oil demand from Canada. In another possible outcome, if central banks announce another massive quantitative easing program and tensions remain elevated in Iran, the Canadian Dollar would be poised to be a top performer in the months ahead.

5.     CPI dropped once again in Switzerland and this could justify more action from the central bank. Do you think that the SNB will raise the floor under EUR/CHF in its rate decision this week, prefer to surprise the markets or refrain from action?

I’m rather mixed on how I feel about the Swiss National Bank’s impending decision this week. On one hand, there is substantial economic data to vindicate the SNB’s decision to raise the EUR/CHF floor to 1.2500 or 1.3000. Inflationary pressures are essentially absent and with the key interest rate already at zero, there’s not much room left to stoke growth given the saturation of the labor market. A weaker Franc would help, so raising the floor to 1.3000 seems like a given. On the flip side, the 1.2000 floor hasn’t really been challenged, so from the market perspective, there’s little evidence to suggest a more manipulative SNB is needed.

Overall, I lean towards the belief that the EUR/CHF floor will be raised to 1.3000, but I would not be surprised if it did not occur at this meeting. The medium-term downside pressures the Euro-zone crisis posses suggests that an immense flight to safety is on the horizon, and to prevent traders from allocating funds into the Franc, and thus weighing on the EUR/CHF, I believe the SNB will act in a preemptive manner.

You can follow Christopher Vecchio’s very informative tweets @CVecchioFX

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About Author

Yohay Elam – Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I’ve accumulated. After taking a short course about forex. Like many forex traders, I’ve earned the significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I’ve worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.