Euro Rebounds on Dollar Weakness

In the past week, EURUSD has lost more than 200 pips from its record highs.   But recent evidence shows signs of a retracing, with support for the euro regaining strength.  But it’s not like currency traders have fallen back in love with the euro.  Most of the movement in the currency pair in recent days has to do with softness in the US dollar, rather than any inherent strength in the European currency.

The data emanating from the continent is contradictory, to say the least.  Recent sentiment reports in Germany and France have bordered on terrible.  Retail Sales in Germany printed last night at a disappointing gain of 0.7%, versus 1.2% expected.  But unemployment fell by 45K, bringing the unemployment rate in Germany to 6.3%, the lowest level in that country in 14 years.  The forex market, understandably, is perplexed as to do what to do with this information.  And so trading in EURUSD right now consists of range trading within 40-60 points, with a market consensus of about 1.37.

The fundamental status of the US dollar is important in this situation because the euro is where the forex market likes to register its response to status changes in the greenback.  But even considering that, there’s no real direction for the currency market to follow.  The PCE deflator was released this morning, and the inflation register came in at 1.9%, excluding most food and energy costs.  This fits into the Fed’s comfort level of 1-2%, but the PCE deflator has a tendency to understate inflation.  Along with that, consumer spending met expectations with a gain of 0.1%, but the pace of growth is the slowest in nine months.  Home prices are also a concern, with the S&P/Case-Shiller index reporting that home prices in 20 US cities fell 2.8% in May—the biggest fall in more than six years.  But those negatives are tempered by the fact that disposable income in the United States rose 0.4% last month, outpacing spending for the first time in months.  The forex market did what it usually does with conflicting data like this: nothing.  The dollar barely moved at all against the yen and the euro after the release of the government report.

Currency traders may be confined to range trading in the near future, especially when it comes to EURUSD.  If you had to choose between the euro and the dollar, however, then your safer bet would be to go for the euro.  The ECB is only charged with maintaining price stability while the Fed has a dual mandate of controlling inflation and promoting growth.  Because of this, the ECB is likely to raise interest rates in September despite French President Nicolas Sarkozy’s concern for the negatives of a strong currency.  In contrast, chances are good that the US Fed will lower interest rates by the end of this year.  And so yield-hungry currency investors will abandon the dollar and flock to the euro.

One way to capitalize on this flow is to invest in a managed currency fund.  Bloomberg reported this morning on record returns achieved by these funds this year, and they are an excellent way to diversify your portfolio.  There are a number of very good funds out there right now, and one of the best in FXCM’s Sentiment Fund.