Euro-Dollar Update

We identified and continue to track key forces that offer insight into the euro dollar exchange rate.

To monitor the near-term trend, we have used the 5 and 20 day moving averages. They have done a fairly good job of capturing this year’s big trend moves with minimal whipsaws. The 5-day average crossed below the 20-day last Thursday for the first time since Sept 13, but is moving back above today. Essentially the euro has been trading in a trading range in recent weeks. The euro peak was recorded on Oct 15 near $1.4160. The low end of the range was recorded three sessions later near $1.3700. It is not unusual for these moving averages to generate false signals (whipsaws) after a large move and as the momentum stalls.

In addition, many traders have drawn a trend line off the Oct 15 high and the $1.4080 high of Oct 25 which caught Monday’s high near $1.40. Some technicians see this as a break out of a consolidative triangle pattern that would project potential move $1.43-$1.44, which corresponds to what we identified as the risk and it where the euro’s down trend line drawn off the record 2008 high and the late 2009 high comes here in Q4.

The second factor we continue to monitor is the premium the market pays for euro puts over euro calls equidistant from the forward strike. A year ago the rising premium for euro puts over euro calls boosted our confidence that the euro was going to come off. Even though the euro is near the upper end of its recent range, the premium for euro puts is greater yesterday and today than any time since late Sept. While some players cut short euro positions, this suggests other have bought some protection in the options market.

The third factor we are tracking are the interest rate differentials between Germany and the US. The 2-year spread continues to stabilise and is trading near it 5 day average near 63-64 bp in Germany’s favor. The 10-year spread is at about 14 bp favoring the which is slightly more than the 20-day average and is at the upper end of where it has traded in the past three weeks.