Earlier this week, I read yet another financial analyst speaking very matter-of-factly about whether Spain should, or will be forced to, leave the euro. Not two weeks ago, the discussion was that the only salvation for Greece would be a return to the drachma.
Of course, talk, particularly from market analysts, is cheap, and, at this moment, the market appears to be dismissing this traumatic talk as just that.
The euro has dipped twice over the past month, taking with it commodities and other risk assets, but, in both instances, has recovered, if a bit nervously. But it still stands well below the near 1.50 highs seen as recently as late April.
Gold and the Swiss franc have been the unabashed winners over these past weeks, as the market appears uncomfortable with getting too long dollars. In fact, despite this price action and the impending end of QE2, which, theoretically at least, should end the low, low, low US interest rates and put a floor under the dollar, there are no dollar bulls to be seen.
Except, humbly, for yours truly. A few days ago, my sister returned from a visit to New York, and brought me this grotesquely-lovely all-American tie. It had the stars and stripes as the background and an image of the oxidised-copper-coloured statue of liberty covering most of the foreground. I was dressing for work when it arrived and had a green shirt on. The tie matched wonderfully, so I put it on and as soon as I got to the office, I called up one of the business channels and told them they should interview me as The First Dollar Bull (2011 edition), which they duly did.
So, there — I am committed. I believe the dollar will strengthen and stay strong for a reasonable (?) period of time, long enough for most dollar bears to die out or change their tune.
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Building my case is, among other things, the fundamental structural problem with the euro. Currently, the entire political establishment in Europe is committed to saving the euro — no domestic politician in Portugal or Spain or, heavens, Italy, wants to be remembered as the one who presided over the ignominious exit, however sensible it may turn out of be after some time. Note the absence of Greece and Ireland in that list — the politicians there appear to be thinking the unthinkable already.
Additionally, the entire European banking system would come under enormous pressure, as would the carefully built up post-euro business processes. Transaction cost savings already baked into P&Ls would evaporate, not to speak of the enormous administrative costs of such a fundamental change.
Thus, there is a huge short-term interest in saving the euro, which is why it may well survive the current bout of nervousness for some more time. But, as the title of this piece asserts — third time lucky! The next bout of euro pressure will be real — you can’t sustain the unsustainable forever.
When this will happen, is, of course, the multi-billion euro question.
Now, I am no technical analysis wizard, although I do completely buy the underpinnings of the discipline: that all systems move in cycles. My cursory examination of the EUR/USD (and, indeed, DXY) chart seems to suggest the formation of a head-and-shoulder (reverse in the case of DXY) pattern, which indicates that if EUR/USD falls below 1.40 again before climbing above 1.49, it would set up a target of 1.31!
But wait, that’s not all. If, indeed, this were to come to pass in a “normal” manner — meaning with some intermediate volatility, it could trigger the set-up of another head and shoulders, which would have a target of 1.12 or 1.13 or so.
Now, at that level, it would be hard to find any dollar bears surviving.
Of course, this sort of decline could take a long time and be interspersed with several “corrections”, some of which would be deep enough to give the by-then growing tribe of dollar bulls a scare. Indeed, this newly forming trend I see could even be aborted at any time. That is the nature of markets and why medium-term forecasts are so fraught with uncertainty.
However, if what I see does turn out to be real, the rupee would obviously react in tandem. In the first phase, where the euro falls by around 6 per cent, the rupee will likely fall by around half that — but that itself suggests 46.50.
With forward premiums at 6 per cent a year and unlikely to fall materially, importers and companies with foreign exchange loans are stuck between a rock and a hard place. The Reserve Bank of India’s recent restrictions on using simple structured products aren’t helping things.
Time to seriously refocus on risk management.