Given the weak close in the EUR USD on Friday, expectations were for the selling pressure to continue this week with the October bottom at 1.3145 the next downside target. Even though downside momentum was strong, a change in sentiment took place over the week-end, triggering an early session short-covering rally.
The sentiment shift was caused by the leak of a plan to allow the Euro Zone countries to begin implementing their fiscal restraint and financial austerity measures much sooner than expected. Originally, the plan called for the European Union nations to make changes to its treaty which would allow it to enforce new financial rules designed to force countries to follow the new financial austerity measures.
By by-passing the need to ratify the entire EU treaty, the alliance of nations found a way whereby a majority of nations may make individual agreements. This would speed up the process, allowing the EU finance ministers the right to enforce austerity rules and perhaps manage the growing sovereign debt problem much faster than previously estimated.
Although this seems like a short-term fix, short traders have responded by lightening up their positions. While not officially a “risk-on” scenario, bullish speculation is strong enough to spread to equities, commodities and commodity-linked currencies, sending these asset classes higher.
Next week is the European Union summit. Is it possible that this news was leaked ahead of this meeting so that the EU leaders wouldn’t have to deal with a currency crisis had the Euro been selling off sharply into the summit? Although there is speculation that the plan to form a pact among EU members will be announced at the summit, many traders are taking the possible announcement with a grain of salt. And why shouldn’t they, given the track record of the EU in terms of implementing its plans to stem the expansion of the sovereign debt crisis.
Monday’s short-covering rally is not likely to change the trend to up. Instead, bearish traders should look for it to set up another selling opportunity. Despite recent efforts by the European Central Bank to ‘save” Italy and rumors of a bailout of Italy by the International Monetary Fund, it looks as if Italy has become a lost cause. Last week’s downgrades of Portugal and Hungary are two more signs that the EU is losing control of the situation and may not be able to contain the spread of bad debt.
With all of these negatives piling up, it doesn’t make sense that the October bottom at 1.3145 should remain intact. After all, wasn’t this bottom formed on the thought that the EU was close to formulating a long-term plan to recapitalize the banks, bailout Greece and provide for a fund to prevent the spread of toxic sovereign debt? Since the debt crisis has worsened, it makes sense that all of the gains established since October 4 should be wiped out.
Technically, the EUR USD main trend is down on the weekly chart. Key resistance this week is a downtrending Gann angle at 1.3447. Fresh selling pressure may come in if this price is tested. A close above this level will likely lead to a 50% retracement of the break from 1.4247 to 1.3212. This price is at 1.3729.
Traders have to be patient at this time to allow for a new shorting opportunity to set up. With negative news outweighing any positive news, the way of least resistance still seems to be to the downside. Give the bottom-pickers some credit this week for stepping in ahead of next week’s summit. Once the summit is over, expectations are for the main down trend to resume.