3 Events That Could Wreck Euro Shorts

01/11/2012 7:00 am EST

Focus: FOREX

Shorting the euro has been a go-to trade for many months, but euro bears need to be keenly aware of these three factors, which could cause a sharp, sizable correction and turn positions against them.

Since mid-December, the euro has been the new funding currency of choice, especially versus high-yielding commodity currencies such as the Canadian dollar (CAD) and Australian dollar (AUD).

But will it continue?

The Eurozone’s long-term refinancing operation (LTRO) is a crafty form of quantitative easing (QE) to provide the EU with easy cash to soak up high-yielding sovereign debt. Still, sovereign debt concerns persist.

The recent German and French bond auctions were lackluster, a bad sign for Europe, as these are the two anchors of the Eurozone economy.

Downgrades are expected to continue, and a heavy Eurozone debt refinancing schedule is on the horizon. In 2012 alone, 250 billion euro in unsecured bank bonds will mature, and the European Central Bank (ECB) will have to accommodate sovereign needs in the months ahead. Reserve requirements dropping from 2% to 1% will kick in for the maintenance period beginning January 18. A second three-year LTRO will begin at the end of February.

With improved US data, such as a steady rise in job creation, higher ISM data, and a third round of quantitative easing unlikely, we are beginning 2012 risk-on. With high-yielding currencies such as AUD, CAD, and the Brazilian real (BRL) on the rise, the new low-interest-rate currency being used to fund risk-on trades is the euro.

See related: What Is a “Risk-on” Trade? 

Here are three reasons to be careful trading the euro:

  1. Market participants are taking heed and being cautious. The CFTC's Commitment of Traders (COT) report shows euro shorts at historic levels, leaving the door open for a sizable correction on good news from the Eurozone
  2. Secondly, the fourth-quarter earnings season kicks off this week. These numbers are important because aluminum reflects broad economic trends and can give guidance as to whether the US dollar (USD) will continue to strengthen. A disappointing number could spur a euro/dollar correction
  3. Thirdly, with US debt negotiations scheduled to begin again in February, the markets are taking a cautious approach before getting too long USD. Any indication of failure in Washington could become a real USD negative

By Michelle Tombasco, junior foreign exchange trader, PFG Best

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