European situation just got worse last week. Chancellor Merkel's reluctance to embrace euro-bonds caused further flight away from risky assets into safe haven assets. USD has been the biggest beneficiary of this latest risk aversion in the markets.
Euro/dollar is hanging by the thread; it is about to break below $1.32. FX pundits see Euro capitulation and a retest of 2011 low of $1.28. Lack of consensus among EU leaders in terms of providing further liquidity to troubled nations--Italy, Spain, Portugal, Greece--may expedite this precipitous fall.
While I don't want to be heroic here and put a "long" position on euro/dollar, I think, it is unlikely that euro will see further decline and may in fact, bounce back violnetly. My rationale behind that thesis:
1. There are too many "euro shorts" with a finger on the "buy" button, if "behind-the-scenes machinations" lead to a substantial liquidity provision to this rapidly worsening debt markets in Europe.
2. USD is only a safe haven currency in times of crisis, and fundamentally is not that strong.
3. There are many central banks, China including, who in the recent past made strategic decision to diversify away from USD into euro, as Fed's QE 2 flooded the banks with dollars. These central bankers will be keen on protecting their investments, as opposed to going back to the USD, which is fundamentally on a long-term decline due to worsening fiscal situation in the US.
4. At least in the near-term, the EU leaders will not allow the disintegration of the EMU and the common currency. Collapse of euro-zone could have a cataclysmic effect on global economy and financial markets. So, even though, most analysts feel that EMU will see some kind of re-structuring, there will be every effort to delay this inevitable event, and let the markets digest this eventuality in an orderly fashion.
So, I think Euro will bounce back to $1.36 in the first week of December. But, I am more interested in other currencies that are being clobbered along with the euro. I would prefer the following trades if the "bloodbath" continues next week:
Buy AUD/USD right around $0.9650 - despite China slowing down, commodities such as gold and silver will find buyers and Australia will benefit from that
GBP/USD has declined quickly to $1.54 level from a very recent high of $1.61. UK is implementing it's own version of QE, however, they are also one step ahead of the US in terms of dealing with their fiscal situation through austerities. I would buy it between $1.52 - $1.54 and ride it all the way to $1.60.
I have had reasonable success trading another "risk currency"--Norwegian Krone (USD/NOK pair). In recent days, NOK has declined by nearly 4,000 pips to 1USD = 5.93 krone. I will be perfectly fine to short the pair (forecasting a rally in NOK) around this level all the way to NOK6.00. I would do it in small increments (few short positions foe every 150pip appreciation in the USD) and put a stop-loss at 1USD = NOK6.0200.
I think the Chinese, the US Fed and Germany & France will step in to prevent a massive shock to global markets and specifically, prevent upheaval in the FX markets. It could happen in a week or two and then the "risk-on" trade will flourish until the year end.
Of course, all forecasts are mere predictions based on "knowable" variables while "black Swans" lurk in the shadow. That's something I have clearly understood ever since I humbly accepted Nassim Taleb as my Guru. Nevertheless, it is too early for the world leaders to accept defeat in the hands of the gigantic "debt beast" that is gradually swallowing profligate nations. The destruction will come in massive scale, but in the meantime, there are opportunities to execute profitable trades, as the waves of optimism and pessimism persist in the FX markets.
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