Euro’s Eight-Month High at Risk on ECB Stimulus: Market Reversal

Trading patterns in the euro show its rally to an eight-month high is vulnerable, as a political crisis in Italy and speculation the European Central Bank will pump liquidity into the financial system weigh on the currency.

The euro’s 2.5 percent rally since the end of August, bigger than any monthly gain since April, pushed the currency through the upper level of the 30-day Bollinger band, signaling a turnaround is imminent, data compiled by Bloomberg show. It climbed to as high as $1.3588 today, a key Fibonacci level that may act as a barrier to further increases.

While the euro has surged this year as the currency bloc emerged from its longest-ever recession, ECB President Mario Draghi said Sept. 23 he’s ready to deploy another long-term refinancing operation to fund banks. That risks devaluing the euro, as does Italy’s political turbulence, in which the five-month old government teeters on the brink of collapse.

“As you start to push up from $1.36, the ECB starts to become uncomfortable and we’d expect more rhetoric to come out from the members,” Christian Lawrence, a strategist at Rabobank International in London, said in a Sept. 26 interview. “Draghi will hint at the option of another LTRO, and the market will start pricing it in every time he talks about it.”

Depreciation Seen

The euro has surged from its low this year of $1.2746 on April 4, and was at $1.3530 at 1:52 p.m. in New York. Rabobank predicts the currency will weaken to $1.32 by year-end, while the median forecast of more than 60 analysts surveyed by Bloomberg has it depreciating to $1.30.

Europe’s common currency lost 6.5 percent in the last two months of 2011 when former Italian Prime Minister Silvio Berlusconi resigned and the ECB said it would allot unlimited three-year cash to the region’s banks to boost lending.

The fallout from a potential government collapse in Italy following a non-confidence vote tomorrow and the possibility that Draghi takes new steps to ease monetary policies on the same day will weigh on the euro, according to Valentin Marinov, the London-based head of Europe Group of 10 foreign-exchange strategy at Citigroup Inc.

The currency first breached the upper limit of its 30-day Bollinger band on Sept. 18 when the Federal Reserve refrained from trimming the $85 billion it spends every month buying bonds. It touched $1.3588 today, the highest level since Feb. 6.

‘Losing Momentum’

“It has struggled to extend its post-Fed rally, and does seem to be losing momentum,” Niall O’Connor, a New York-based analyst at JPMorgan Chase & Co. who watches trading patterns to figure out where asset prices may be headed next, said in a phone interview on Sept. 26. “If you look at any momentum indicators it’ll show the short term setup is overbought.”

Bollinger bands, developed by John Bollinger in the 1980s, are used by technical analysts to identify the turning point in an asset’s trajectory. The limits represent two standard deviations from the 30-day moving average, implying that the likelihood of a currency moving outside the band is rare.

The euro’s 14-day relative strength index rose as high as 69.2 last month, just short of the 70 threshold that signals a turnaround is imminent.

Though strategists are betting on a weaker euro, they have trimmed their bearish calls. The median forecast of more than 60 estimates in a Bloomberg survey is for it to end the year at $1.31. In July, the median was $1.26.

The euro has rallied 5.4 percent this year, the best performance among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes.

Speculator Bets

“Stronger growth and improved sentiments are particularly euro-positive,” Sara Yates, the global head of foreign-exchange strategy at JPMorgan Private Bank, said in a phone interview on Sept. 20. Yates predicted the currency will stay in a range of range of $1.28 to $1.36.

Hedge funds and other large speculators accumulated the most euro-bullish bets against the dollar since May 2011, according to data from Washington-based Commodity Futures Trading Commission compiled by Bloomberg.

The difference in the number of wagers on a rise in the euro compared with those on a fall, or net longs, totaled 65,844 contracts on Sept. 27, more than double the previous week.

“Long-euro positions are getting crowded,” Kasper Kirkegaard, a senior strategist at Danske Bank in Copenhagan, wrote in a Sept. 30 report. “It implies that positioning has now become a downside risk to euro-dollar, and not an upside risk factor as during most of the European debt crisis.”

Euro Economy

While the euro area’s economy grew 0.3 percent in the three months ended June, ending six straight quarters of contraction, the manufacturing sector may be showing signs of strain as a stronger currency hurts exporters’ competitiveness.

The euro-region manufacturing index declined to 51.1 in September from 51.4 the previous month, and business confidence in Germany rose less than economists forecast.

“My own personal view is that euro strength is a problem in the euro area, especially a country like Italy, for example, which has a very strong export sector,” Larry Kantor, head of research at Barclays Plc said at a press briefing in New York on Sept. 26. “Probably the single most important thing they could do is get the euro down. The biggest threat to the euro area right now is growth.”

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