The Fashionable FX Trade for 2012

11/23/2011 6:00 am EST

Focus: FOREX

Sean McGillivray

Vice President, Great Pacific Wealth Management

Eurozone debt problems won’t be going away soon, meaning the most compelling opportunity in world currency markets is still going short the euro against counterparts like the Japanese yen.

Better late than never? In a stunning reversal of sentiment, it appears now that every investment bank analyst just realized that the European Union is one gigantic mess. I wonder what rapidly deteriorating metric they have chosen to justify their new view.

Was it short-term Greek paper yielding over 5000 basis points (bps) for the past 12 months? Consistent credit downgrades by major rating agencies of Italy, Spain, Portugal, Ireland, and Greece over the last two years? Or is it just that their sovereign debt holdings are finally reaching maturity?

Whatever the reason, the hottest investment fashion for 2012 is to be short the euro. This week, Credit Suisse joined the party with a research note ominously titled: The “Last Days” of the Euro.

See related: It’s High Time to Short EUR/USD

With numerous buy-side analysts finally saying the same thing we have been yelling from the rooftop for two years, how does the average trader or investor take advantage?

Obviously, individual traders and investors are not going to build an elaborate portfolio of short- and long-maturity European credit default swaps, but you could invest in a trend-following CTA program. That is correct; the complex world of sovereign debt can be traded in your plain old managed futures account.

See video: Managed Futures Demystified

Excluding the outright short in the euro currency futures, technical trend-following CTA programs have numerous opportunities in other highly event-correlated markets to trade. See, if/when the European Union unravels, traders will increase their short exposure to the euro currency. This will lead to other markets that tend to correlate well to the euro currency moving as well.

A trade that I would expect to work well would be long Japanese yen and short euro. This spread will most likely be taken advantage of by both trend followers and spread trading strategies. Due to the Euro’s high correlation to “risk,” I would also fully expect long bonds and short equities to work well during the initial breakdown of the currency.

The risk to next year’s most fashionable trade: the EU does everything it can to keep up the status quo. As I stated above, we have been hammering on the fundamentals of a weak euro for two years with little success in our trading accounts. The metric to watch, in my opinion, is a jump in French ten-year paper.

Stress in the “strong” euro members will only mean that the “weaker” countries are truly the disaster we have always thought, and Germany and France are not far behind.

By Sean McGillivray

Sean McGillivray serves as vice president of Great Pacific Trading Company and president of Great Pacific Capital Management, a registered commodity trading advisor. At both firms he oversees asset investment of client funds based on the sophisticated allocation strategies he personally developed.

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