(09/13/12) The Euro Is in Play

Europe may be have a tough time sorting out its economic mess, but the euro is in rally mode, and it's likely to continue as the European Central Bank and the Fed keep juicing up their currencies, says Dean Popplewell of OANDA.

Gregg Early: I’m here with Dean Popplewell, who is the Chief Currency Analyst with OANDA. I think today, more than ever, foreign exchange trading has become one of the biggest and most popular vehicles out there for trading and simply for investors even at this point.

Maybe it’s best to start with a basic question with everything going on in the markets as we see them in Europe. We have the euro collapsing, and the United States, and then you have China moving into the picture. You have developing markets. What is it that you’re looking at today that most interests you, Dean?

Dean Popplewell: Well, as you correctly mentioned there, the three dynamics of Europe, North America, and obviously China in the fray.

The euro seems to be the currency of choice at this moment in time, and what we have seen over the last six or eight months, it’s certainly the euro under constant pressure to the Eurozone debt crisis issues. Obviously, the debt-laden countries like Spain and Italy and Greece themselves having financial problems investing in the fixed-income markets.

The euro tends to be the currency of choice amongst most investors out there, either to speculate or to avoid, certainly, and with China on the back burner and concerns there on growth, people are also looking at emerging markets as well. The issue of a low-yield environment in other asset classes like fixed income certainly allows trading in currencies to become more attractive for the average investor.

Gregg Early: Now, there’s been talk recently that Japan seems to be coming back and has greater inroads to China than ever before, and that with the infrastructure spending after the tsunami and all that, Japan is looking up. Are you seeing any interest in the yen, or that still a fundamentally dead currency, for the most part?

Dean Popplewell: It’s not a fundamentally dead currency. The actual appreciation on what we’ve seen over the last eight months or so is obviously a major concern, both to the Ministry of Finance and The Bank of Japan.

The currency is being used traditionally as a safe-haven currency, and it’s becoming far too strong for Japan’s trade interests. Globally, investors tend to use it as a certain, safe-haven vehicle, and obviously the stronger the yen has become, it’s a detriment to global trading from Japan’s perspective.

On the flip side of that, people have also been using other safe-haven currencies like the US dollar...but what we’ve seen over the last month or so is certainly a huge reprieve in the euro, mostly on the back of what the ECB is trying to implement with its OMT and bond buying initiatives that they’re hoping to implement and help alleviate the debt financing issues and concerns of the euro-periphery countries.

Next: So its the headline currency

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Gregg Early: So it’s the headline currency, the euro at this point that is drawing the most attention. Plus it’s been beaten up so much that it’s a much more interesting currency to speculate in.

Dean Popplewell: Yes. Globally, what we’ve seen—certainly over the last 18 months—is that the euro has been a net favored to short trading position, or certainly a trading strategy of most investors.

What Europe has been trying to implement over the last couple of weeks, and specifically over the last ten days and with Germany ratifying the constitutionality of the ESM Program and bond buying, it certainly has alleviated some of the selling pressure of the euro. In fact, we’ve actually seen the euro trade at five-month highs.

Obviously, when we have a stronger euro we certainly have an underperforming dollar, and the dollar is certainly trading very much underweight ahead of the FOMC decision in Aspen, where a lot of the market is expecting or is anticipating that Bernanke and the Fed will progress down the QE3 path of further easing.

Gregg Early: I guess the question is if the euro has rallied, and it’s hitting new short-term highs at least, the question is this is going to continue, I would assume, until things get sorted in the US with the Central Bank and Europe with the ECB. Is that fair enough to say?

Dean Popplewell: That’s a fair enough statement. Obviously, we have a lot of event risks over the next couple of months. We’ve got obviously the Fed and QE3, whether they implement it or not. We’ve obviously got the presidential election in November.

We’ve also got concerns about whether China is experiencing a soft landing. Global growth concerns are always a major issue over the last 18 months, and whether the euro as a speculative currency has been oversold.

It certainly looks that way. Those bearish positions are certainly being squeezed out over the last ten days or so. But how much upside has the euro got from here? It certainly seems to be overbought.

The dollar seems certainly to be oversold, to a certain extent. And when you start looking at central banks, have they or will they be capable of achieving this coordinated easing intervention, whether it’s by the Fed or whether the ECB or whether China needs to apply further easing?

But at the moment, when we’re looking at the currencies that were very much oversold or certainly a stronger bearish sentiment, like the euro, it seems to be that the market has been caught offside. They have wagered too great a bet that Europe was going to fail.

What we’re seeing, or what the market is telling us currently, is that the ECB is far stronger and is very determined that Europe will survive. This has squarely got a lot of speculators caught offside, and we’re seeing a lot of new money in buying the euro.

It certainly makes for an interesting next couple of weeks with the previous event risks that I tabled later coming on board.