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By Shavasb Bohdjalian
Sentiment on the euro was hurt by the failure of European policymakers to calm markets about a Greek default and the risk of the debt crisis engulfing larger euro zone economies and banks.
Earlier in the week, the euro rallied higher in anticipation of a breakthrough at the Ecofin meeting in Poland over the weekend and also because of technical factors since the short term situation was heavily oversold and the market was ripe for a correction.
The fact that there was a cool reception for US Treasury Secretary Geithner and his calls for European action at the Ecofin summit did not inspire confidence. European Finance Ministers rejected his proposal to leverage the EFSF; and in return there was no US support for the European financial tax.
A cancellation of a visit by Greek Prime Minister George Papandreou to the United States to chair an emergency meeting and a regional election defeat for Germany's chancellor Angela Merkel added to the growing sense of crisis.
The EU and IMF have presented Greece with a list of 15 measures it needs to accelerate as a condition for disbursing a next tranche of bailout funds, with a final decision on the next tranche of aid for Greece postponed until October.
Some players judged that would take the decision on the payment — essential to avoid a default by Athens — right down to the wire, a prospect that will hurt the euro in coming days.
There is no doubt that the Greek situation is deeply unsettling for markets and is indicating that a short trade may be profitable, but the key for the next direction of the euro against the other currencies will come tonight (Wednesday evening at 9.15pm Cyprus time) after the Fed’s two day meeting of the FOMC is concluded.
A report in the WSJ suggests that Operation Twist is the most likely outcome from the meeting, with some mention of a cut in interest paid on excess reserves. In simple terms, Operation Twist is the term given to explain how the Fed will refrain from buying short dated Treasuries and instead concentrate on purchasing long dated ones in an attempt to force long term rates lower.
If the Fed does not mention that it is worried about the state of the US economy and all that it will do is commence Operation Twist, then the likelihood of QE3 happening anytime soon will diminish and it will be back to European and Greek events to provide direction for markets. With the agenda from Europe bleak, then it’s probably safe to assume that a break of the previous low of 1.35 on EURUSD will open the way for an extension of the decline in the value of the euro.
On the other hand, if the Fed says it will do Operation Twist to lower long term rates and additionally will expand its Treasury buying programme since it is worried that the US is headed into recession with no decline in unemployment ranks, then watch out for two-way trading on EURUSD and probably a massive rebound from the lows, as it will confirm that QE3 is right around the corner. With the market heavily positioned short euro and expecting further declines in the coming days/weeks, a break above 1.4060 will probably trigger a massive rebound to 1.42 and beyond, depending on how severe the positioning is in the market.
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(Shavasb Bohdjalian is an approved Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, authorized and regulated by CySEC, license #114/10. The views expressed above are personal and do not bind the company and are subject to change without notice. Investing in markets and trading on leverage is highly risky and it may not be suitable to all investors since it carries a high degree of risk and you can lose more than your initial investment)
