Euro Rallies on Outbreak of Optimism

The euro market loaded has an abundance of speculative shorts, according to the last COT data. A few optimistic comments from the right people seems to be all that was needed to start a rally. With German Chancellor Merkel hinting, through her Christian Democratic Union's budget chairman, they would be willing to make some small concessions to the Greeks – this seemed to get the ball rolling.

This is good news for Greek Prime Minister Samaras who is scheduled to meet with Merkel, and later in the week with French President Francois Hollande. It remains to be seen if the austerity requirements will be lightened or there will be any plans to stimulate Greek growth.

The five-year recession has reduced the Greek GDP by over 20%, a real depression. The original austerity plan called for the Greeks to sell state owned assets to reduce debt. In a depression there are not many domestic buyers, and finding foreign investors is a fruitless endeavor.

Despite some of the negative rhetoric calling for the expulsion of Greece from the euro, Germany does not want to be viewed as the cruel creditor that evicts the Greeks. It remains to be seen how this plays in Greece, but a few token concessions may not be enough to appease the populace; the democratic roots in Greece are not deep. It is too early to pop the champagne cork, celebrating the end of the Greek Crisis.

The continued rumors the ECB, despite the grumbling Bundesbank, is going to buy some bonds and pump some liquidity into the market, has debt yields decreasing. Yesterday, Spain sold €4.5B 12 and 18 month bills. At a yield of 3.07% basis the 12 month, this is down from the last auction when it traded at 3.918. German one-year bills yield a negative .03%.

In Portugal, the 10-year bonds dropped to a 15 month low, 9.25%, and in Ireland yields on nine-year paper dropped to a low of 5.96%. The debt markets sense a change is coming, so ECB President Draghi had best deliver.

How much more can the euro rally?

Well, the futures specs are still short, but most of these are the big specs, probably funds, who are well-heeled. It is, however, the dog days of summer, when trading can be light and erratic. They used to claim many traders were on vacation, away from the markets, but with all the communication devices we now have, this is probably no longer true, unless you are in Siberia or maybe Palawan.

My guess is this is not a time when new trades are initiated, but bad ones may be taken off.

The EURUSD made a good trade today when it took out the previous tops at around 1.2442. Looking at the MACD on the daily chart, it is giving us a buy signal. The shorter term chart shows the pair overextended, but a quick retracement to the 1.2390 level looks like support. As long as we continue to get optimism from the political chattering class, the rally can continue, perhaps to the 1.2650 area.

Looking further ahead, I fail to see reasons to expect growth in the European economy. Further, soaring energy costs will be a nasty drag on global economies, so the 1.2650 might be a target to establish a short position in the longer term.