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Saturday, 29 September 2012

Is the Euro Decline Limited?

The euro is correcting to 1.2650. However, the medium-term trend is positive. The EUR/USD could reach 1.38/1.44 by year’s end. Can the so-called “fiscal cliff” be overcome?

Uncertainty is growing.

The ECB has probably found a solution to the crisis in the Eurozone. A debt-sharing plan will take the pressure away from the weak nations and put the European challenge in the backseat for a while. On this side of the Atlantic, however, the fiscal cliff could determine bold cuts in spending and increase taxes to about 5% of the GDP on January 1. Under these conditions, hiring and investment would be postponed. 
Uncertainty is already weighing on the economy. In August, durable goods orders fell 17.8% annualized. It was the sharpest decline since 2009. Factory machinery slumped 13% in the past three months, while computers and electronic parts fell 9%. It is true that consumer spending has improved slightly, supported by healthier real estate and stock markets. Nonetheless, the economic growth could sink once more, if the fiscal cliff is not resolved quickly. 
Germany is holding, but for how long?

According to an EU business and consumer survey, confidence is still shrinking in Europe. In September, the economic sentiment indicator (ESI), a forecaster of GDP growth, fell for the sixth consecutive month and reached the lowest level in more than three years. The indicator has deteriorated in most sectors. Unemployment rose to 11.3% in July, the highest level of the past thirteen years. Germany remains resilient, but is beginning to feel the heat as well. The IFO business climate index declined for the fifth consecutive month in September. The German unemployment rate, however, has stayed near the lowest level since reunification.
The EUR/USD could decline to 1.2670 over the short-tem. It would complete a larger head-and-shoulders formation that started in January. According to the latest Commitment of Traders (COT) report, funds are reducing the short positions accumulated since the third quarter of last year. New buying stays subdued for now. Risk is still high. The situation is particularly challenging in Spain, where Prime Minister Rajoy could ask for financial help soon. However the EUR/USD is now supported by the ECB’s decision to buy securities in the secondary market unconditionally. A move above 1.3470 would take the euro to 1.38/1.44.
Angelo Airaghi,
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