The euro’s troubles are far from over

As of Friday mid-afternoon, the euro looked set to end a difficult weak on a high. Eurozone inflation came in slightly above expectations, raising hopes that regional deflation could be on the wane. At the same time, US unemployment cost index data came in above estimates, a development that only added fuel to the euro’s fire and the dollar’s retreat.

EUR/USD weekly

As good as this week has been for the euro, the trend is still mixed using an optimistic interpretation or negative when looked at from a longer term perspective.

By contrast, the US dollar index has been on the rise since June, with Friday’s sell off firmly against the longer term trend of the summer so far.

Dollar Index Daily Chart

Looking at the bigger picture, stock markets are banging on the door of the highs, but are stuck between the good news potential of a US economic recovery and the bad news of quicker interest rate hikes.

S&P 500

The S&P 500 and euro’s short-term trends are curious given the perilous nature of the current Greek agreement. The US benchmark has been relatively sensitive to the prognosis on Europe, with large gaps lower on the weekends of headline grabbing talk deadlocks. The market’s enthusiasm for recent US data and Fed comments is understandable, but its trust of the recent Greek deal is not.

There are some gaping holes in the Greek negotiations with creditors, especially with regard to the IMFs stance. Reports emerged on Thursday that the International Monetary Fund may be unwilling to participate in the third bailout unless some form of debt restructuring is considered.

The IMF position has already been laid clear – They intimated such concerns within hours of the announcement on the latest bailout deal. Still, it is significant that one of the biggest partners of the Troika is signalling unease while Eurozone creditors breathe a premature sigh of relief.

The optimistic interpretation is that it represents a more concentrated attempt by the IMF to influence politics and policies in Europe. Most objective observers of the Greek debacle are clear that Greece cannot pay its debts without significant haircuts. The most recent bailout introduced stringent conditions that arguably make growth less, not more likely in comparison to the lower tax regimes in other countries.

Whether Europe (Or Germany in particular) can stomach debt restructuring remains to be seen. Germany is one of the biggest creditor nations and will face considerable political if not financial pressure if a debt haircut is in the offing. Sadly, the most likely outcome is an ‘extend and pretend’ approach to coupon repayments rather than admitting capital losses. Aside from this, German finance Minister Schauble remains hostile to Greece remaining in the euro.

Despite the positive end to the week, the euro’s troubles are far from over.

A good way to play this is a LOWER trade predicting that the EUR/USD will close below 1.0900 in 35 days time for a potential return of 216%. Or put another way, betting that the EUR/USD will close below 1.0900 on September 4^th could return £31.82 for every £10 put at risk.

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