We have been
bearish on the EUR/USD for some time now. Some investors are convinced that the USD is going down forever and that the US is the next Zimbabwe. The reality is that while the United States has a ton of issues such as the huge and rapidly expanding deficit, the rest of the world is not exactly in great shape either.
One of the weaker areas of the world happens to be the European Union. They continue to have issues such as Spain and its almost 25% unemployment rate, the IMF estimate that EU banks have only written off 50% of their bad debt, and the potential for major defaults in Eastern European nations.
The timing for a short position is starting to look right. As you can see in the chart below on a purchasing power parity basis the Euro is 35% overvalued to the USD. In previous periods of over and undervaluation this is past the levels that are typically seen before a reversal of trend. (Click on chart twice to enlarge)
Another indicator that we follow is that of FX risk reversals. Risk reversals essentially show how option traders are positioned. A negative reading means that option traders expect a move lower and positive reading mean that they expect a move higher.
Typically we look for contrarian signals at the extremes, usually when the reading is very negative or positive the trade is crowded and the price goes in the opposite direction. This time however is a bit different as option traders are extremely bearish but the spot price has remained strong. Because of this we suspect that if the price breaks we could see a swift move lower.(Click on chart twice to enlarge)
EUR/USD 25R 3M Risk Reversal
Looking at the chart below of the Euro ETF you can see that the price has broken below its current trend line. In the lower panel you can also see that we also have had a momentum divergence during the last part of the advance.(Click on chart twice to enlarge)
All of these signs point to a lower Euro. We think that the timing is right to dip our toes in the water. If the trade starts to move in our favor we will be looking to add to it as it could move quite a bit lower due to how overcrowded the trade is, valuations, and the fact that the EU in our view is just as broken as the US.
Disclaimer-we are currently short the Euro in The Macro Trader newsletter.
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Title: Is it Finally Time To Short The Euro?