As noted here, this week is likely to be a quiet one for markets in general, particularly in Europe and the US as both markets will be mostly on vacation this week. We covered our major observations about lessons for risk assets in general for the coming week here.


So we’ll keep this limited to some summary observations


Last week, despite the EU’s lack of real progress on its debt crisis, the EUR continued its rally due a combination of:


  • The Fed undermining the USD faster than the ECB is undermining the EUR. The Fed is already in QE 4 and printing $85 bln/month for the foreseeable future. The ECB won’t even begin its own version of that, OMT, until some point in the future when/if Spain requests it and a deal on conditions Spain accepts in return for this aid is reached.
  • Increased risk appetite on the above rising hopes for yet more stimulus from Japan and the US that would spur near term risk asset rallies. The EUR is farther towards the risk side of the spectrum than the USD and so tends to rise while key barometers like the S&P 500 index continue higher.
  • Continued belief in a last minute fiscal cliff deal would happen that would defer most of the tax increases and spending cuts
  • S&P upgrades Greece’s credit due to the success of the Greek debt buyback program, aka partial default that technically isn’t considered a default because enough Greek banks and hedge funds agreed to it. Markets are calm about this because


    • Greek banks are expected to be bailed out if needed
    • The hedge funds had bought these bonds sold at a substantial profit, after having bought them even cheaper.


Regarding that Greek credit upgrade: I’d be grateful to anyone out there can please explain what rational basis there is for this belief that Greece is really less likely to avoid default.


S&P is not a group of softies – they correctly stripped the US of its AAA rating when Washington couldn’t make serious progress on the debt ceiling in the summer of 2011. Yes, Greece’s debt burden is somewhat reduced, but Greece’s prospects for recovery, and its track record for meeting its obligations, are both dismal.


Meanwhile nothing in the EU debt crisis has been fixed. Even ECB President Draghi admits he is only buying time for the EU. The OMT and every other program in the EU remains essentially some combination of:


  • Lending more money to those who can’t carry their current debt load
  • Optimistic assumptions about future improvements in GIIPS nations’ growth rate that may or may not be true, so these nations are at least as likely to deteriorate as recover
  • Plans to print money out of thin air in order to fund GIIPS bond purchases by the ECB and assorted national banks which in turn keep sovereign borrowing costs acceptably low, so that they can borrow yet more money (again, when they can’t afford their current debt loads)
  • Assumptions that funding nation voters  and tax payers will accept continued transfers to debtor nations and debasement of their common currency and any assets denominated in them



Lessons And Observations


  • Risk asset market in general, and forex markets in particular, are not pricing in EU solvency risk beyond the coming weeks.
  • The current EUR rally is based on short term considerations and its uptrend is strictly for short term traders. Longer term traders should stand aside until your indicators suggest a likely reversal.



For a more detailed look at our conclusions for the coming weeks and beyond, see here.


What’s Likely To Halt The EURUSD Rally?


  • General reversal in current risk rally. As discussed here, there is limited upside for risk assets. However given the holiday season low liquidity, barring any major surprises, quiet range bound trade is more likely than a sharp move down.
  • Anticipation of an ECB rate cut
  • Fiscal cliff deal that removes enough of the planned austerity steps to spark a risk rally and simultaneously weakens the USD
  • Any event that raises anxiety about the EZ, like rising Spain bond rates or increased Italian political uncertainty



What Could Further Support The Rally?


Essentially just the opposite of the above.




No major moves in either direction likely this week. However if there are any major surprises the low liquidity will amplify volatility.


Longer term more downside than upside.