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Are you traveling to Europe this summer? You may be in for a pleasant surprise; The euro is on offer. At just 109.00 to the dollar, the euro is nearing lows set during the 2020 Covid collapse. With a current yield of 2.78%, US 10-year Treasuries are paying far more than 10-year bonds from major European nations. This makes the US dollar one of the most attractive currencies in the world. That could change.
After months of trading near or below zero, 10-year European bond yields are starting to rise. With annual inflation in the Eurozone now at 7.5%, the path of least resistance for European yields is now up. The chart below shows the beginning of this upward trend in the main European economies.
Contrast this with the one-sided explosion in US Treasury yields. (See chart below.) We believe this move is a bit ahead of itself and that the huge rise in yields and massive sell-off in US 10-year note prices are overdue for any significant corrections. Combine a correction in US yields with a renaissance in European yields and you have the formula for a euro rally.
Source: Yahoo Finance
War in Ukraine a double-edged sword for the dollar
The war in Ukraine is favorable for the dollar because, as the world’s reserve currency, it is considered the safest place. Most global trade is done with the greenback and for years it was the only way to pay for energy and many important commodities. That now supports the dollar.
However, these benefits can have a darker side. Russia, one of the largest suppliers of crude oil, can no longer get dollars for its crude and currently accepts rubles and possibly Chinese yuan as payment. With 1.6 million barrels per day, Russia is China’s second largest supplier of crude oil. With 1.76 million barrels per day, Saudi Arabia is China’s largest supplier. Saudi Arabia could also soon accept yuan for its oil – especially if sanctions are imposed.
Most of the world’s population centers – think China and India – have a vested interest in keeping the energy taps open to feed their growing economies. Both have decided not to take sides in the war. This is no coincidence. We suspect that China and India will have no hesitation in using a currency other than the US dollar to pay for energy if it is in their interests to do so. This threatens the greenback’s reputation as the world’s “go-to” currency, as well as its high price level.
Euro nearing long-term support
We prefer to use euro futures as a proxy for the dollar as their options are generally more liquid than dollar index options. The euro makes up the majority of the basket of currencies that defines the dollar index (DX) and moves inversely to the dollar index. A strong dollar tends to correspond to a weak euro and vice versa.
Euro futures are testing long-term support just above the low hit during the 2020 Covid meltdown. The war in Ukraine is responsible for much of this decline, but we believe that the economic impact of the war on Europe is already largely priced in. Eurozone inflation is rising fast, helped by skyrocketing energy costs as a result of Europe’s dependence on Russia. Inflation will soon be the next enemy the EU will have to face.
The euro is also approaching support over the long term. Euro futures tested the $1.04 level four times in the past seven years. It bounced off hard every time. It is about to test it for the fifth time. Will it bounce again? Only the market gods know for sure. However, given the current level of inflation in the Eurozone and the need for the European Central Bank to act soon to control it, we are willing to take a firm risk bet on it.
Data source: Reuters/Datastream
Two goals, two time frames
As the chart above shows, bullish moves in the euro can be impressive. We have two targets: first is resistance at old swing highs of $1.14 and second is our ultimate Fibonacci derived target of $1.18. War conditions mean a reversal could begin at any time. Trading clients of the RMB Group should consider taking a flyer to our first target by buying the $1.11 June 2022 CME traded calls. These were billed for $675 on Monday. Don’t pay more than this.
Your maximum risk is the price paid for your call options plus transaction costs. Calls of $1.11 in June for at least $3,750 should meet our target of $1.14 before the option expires on June 3, 2020. Our second goal will take longer. We’ll wait and see what the euro does in what could be an interesting spring for Europe. Prices can and do change, so contact your RMB Group trading expert for the latest information.
Please note that you need a futures account to trade the markets in this post.
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Editor’s note: The summary bullet points for this article were selected by Seeking Alpha editors.
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