Sunday, January 28, 2007

Where is the euro headed?

Everybody had gotten so excited about the rising euro a month ago, but now the momentum of the euro has evaporated and we have seen a modest pullback as people realize that the Fed is not likely to be cutting interest rates any time soon. My current view is that the euro will continue to bounce around in a range for the foreseeable future, possibly between $1.25 and $1.33 for at least the next month.

Frankly, there are simply far too many "stories" going around in financial circles about euro strength and dollar weakness that are almost completely detached from economic reality. Mostly they are fantasy and fiction spun around a tiny core of fact but extrapolated far beyond their factual basis. The simple fact is that people are trying to make money trading off volatility, and the stories are designed not to enlighten investors, but to enhance volatility.

I was just sorting through some stuff from my recent strip to New York City and I had saved the business section of The New York Times from my trip back on Wednesday, January 3, 2007. The right column headline says "Dollar's Skid Puts a Glow On the Euro." Skid? What exactly is a skid? Usually it is trader jargon for a sharp but short-term fall, but the Times article refers to "A steady slide in the value of the dollar since late 2005." That would hardly qualify for a trader's "skid."

In fact, the euro only rose to about $1.33 recently (now back under $1.30) and had hit $1.32 quite a number of months ago, pulled back to around $1.16, rose back up to around $1.25, and finally in December did its "skid" up to $1.33. So, the decline since late 2005 has certainly not been "steady" and overall has not been a "skid."

The Times article goes on to recount some of stories that are going around, but fails to note that people are perpetuating these stories not becaus they reflect fundamental values but because they enhance volatility and hence potential trading profits.

Will the dollar "skid" to $1.40 in the coming months? Sure, it could. A 10% move in either direction is well within the range of volatility that we have seen over the past few years. It is also very possible that we could see the euro "skid" to $1.20 or below as well. And if the Fed raises interest rates to 5.50% in May if the economy continues to gain steam, the euro could "skid" even further.

My call is for the euro to be stuck in a range from $1.18 to $1.38 for the next six months. There are still way too many people who expect Fed rate cuts this year, and the euro will "skid" each time another batch of these people pull back on their betting for those fantasy rate cuts which never arrive.

-- Jack Krupansky

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