The euro is rallying again.
Over the past three months, the euro has appreciated more than 8% versus the dollar. It doesn’t make much sense, really. After all, the European Union is still just a crisis or two away from falling apart. Greece has gone belly-up. Ireland’s new government has been forced to take a bailout. Portugal’s government bonds are trading at enormous discounts. And Spain’s woes are getting worse.
It won’t take much to tip over the whole house of cards… Yet currency traders have been buying the euro.
It just doesn’t make sense.
Until, that is, you consider the plight of the dollar. Let’s face it… The dollar sucks. Please pardon the crudity of that statement. But there is no other way to describe the action of a currency that looks like this…
The greenback has fallen 14% since topping out last June. And it’s down 6% from the high it hit in January.
[ad#Google Adsense]Obviously, the weakness in the dollar is directly attributable to our Federal Reserve Board’s willingness to print as many of them as it needs to buy up enough U.S. Treasury Bonds to keep interest rates artificially low. That’s the goal of the quantitative easing programs.
Dollar weakness contributes to the strength in the price of other assets, including stocks, commodities, and foreign currencies. So the recent strength in the euro is not necessarily due to increased optimism in the fate of the European Union. Rather, it’s caused by dollar weakness.
Currency traders are fleeing the dollar and flocking to other currencies. So the dollar falls and the euro goes up. It’s a logical trade. After all, if the Fed is dead set on destroying the dollar in order to keep interest rates low, they will eventually succeed. But “eventually” can take a very long time.
The short-dollar/long-euro combination is once again a popular trade. It’s too popular.
Markets don’t always work according to logic. And they despise popularity. When too many people pile into one side of a trade, the market has a nasty habit of going the other way.
That’s exactly what happened when the dollar bottomed last April. The greenback rallied 10%, and the euro dropped 10%. It also happened last November. Everyone was bearish on the dollar. They were lining up to buy the euro. The trade collapsed. The dollar rocketed higher, and the euro sank.
It’s all set up to happen again right now. The dollar is ready to rally, and the euro is poised to come tumbling on down.
Everyone is bearish on the dollar. Many newsletter writers are bearish on the dollar. Magazine headlines scream warnings of a dollar disaster. Financial TV talking heads are universally gloomy on the greenback. And while I agree with them over the long term, we’re ready to see a big dollar rally (and a euro fall) in the short term.
Best regards and good trading,
— Jeff Clark
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* Source: Daily Wealth