August Whiplash Effect in the Cards for the Euro?

07/24/2014 9:00 am EST

Focus: FOREX

Tom Cleveland on uses 2013 as an example of what can happen when the majority of forex traders are anywhere other than in front of their computer screens in the generally slow month of August.

Is this the calm before the storm? Do you sense that the starter is holding his pistol high in the air, preparing to give the shot heard round the world, which is the signal to rush for the exits after shorting everything in sight? There is edginess in all market sectors at the moment. Company earnings continue to grow, but these could just be the tail end of outsourcing benefits that seem to keep on coming. The latest stats on outsourcing projects suggest a slowing down to 4% on a global basis, but $443 billion represents a lot of jobs that are leaving developed countries, one way or another.

This eerie calmness continues to pervade the foreign exchange market, as well. The euro appears to be stuck in a $1.35 to $1.37 range, as if preparing for August holiday across the continent. Analysts are spooked by the lack of volatility, but most of the crowd has accepted that volatility is always low in the summer months, especially during August when most all of Europe shuts down for a month of good food, good times, and relaxing along the Mediterranean.

If we take 2013 as a model of what can happen when a majority of Europe’s forex traders is anywhere but in front of their computer screens, the EUR/USD pair suddenly went into reverse gear, then jerked back to life when vacationers called home to check in, a sort of whiplash effect, if you will. As the chart below illustrates, we could be in for a repeat performance in the weeks ahead.

Click to Enlarge

The current boundaries of the blue Bollinger Bands designate the tight range of expectation among the community of forex analysts. Try as they might, neither bears nor bulls can convince either themselves—or their counterparties—why the euro could muster a charge through either boundary. Five fundamentals are driving the current complacency, and unless one or more of these has the energy to burst forward from the pack, the cumulative effect of the group will hold the lid on any fireworks, at least until Labor Day.

Global tensions emanating from the Ukraine and the Gaza strip are not viewed as earth shaking, but the tendency of central bankers and investors to diversify away from the dollar to the euro acts as a counterbalance to risk aversion tendencies. The European Union is plagued by structural issues that politicians refuse to address, but a large trade surplus acts—once again—as an offset to any crippling from this Achilles’ heel. Lastly, neither the US nor Europe is rushing to change interest rates in the near term, and even in 2015, modest limits of 0.25% have already been bandied about in press conferences.

So, here we sit with the world’s most heavily traded currency pair lulling everyone to sleep. You can almost here the ATR indicator snoozing, as it skids to ground zero. The Stochastics are also grinding to a halt, almost willing the euro to rise from its slumber, at least to the Bollinger mean average in the next week or so. Inflation and manufacturing PMI data will be in abundance shortly, but if the past is any indication, these data points will tend to offset one another, contributing to more sluggishness on all fronts.

There is agreement for the long-term of a bearish outlook for the euro, but no one can predict when the downdraft will occur. Too many traders have lost a heap of cash shorting the euro to jump on that train. Expect there to be a severe test of the $1.35 boundary, but also expect it to be temporary.

By Tom Cleveland, Contributor,

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