Gauging the Risks of the Dollar Euro
02 December 2011
TECHNICALS:
WEEKLY CHART
The market is re-approaching the recent low at 1.3149 having failed to break back through the rising diagonal at 1.42.
A break of the 1.3149 low would begin fresh selling.
DAILY CHART
The day chart shows the market’s hesitation above 1.3149.
And in particular the push back up through the falling diagonal and small horizontal resistance at 1.3425.
But besides these small intimations of short-term bullishness, there are no compelling patterns at work.
FUNDAMENTALS:
The Dollar has recently enjoyed a period of strength against the Euro as the Eurozone sovereign debt crisis intensified and as the Euro zone approaches recession. Both events would pose a significant threat to the health of the global economy.
Despite several European and G20 summits, a solution to the crisis continues to elude the bloc’s political leaders. So countries outside the Euro zone are starting to make contingency plans in case the worst happens.
With France and Germany desperately trying to find a formula to deal with the problem, but failing to fill in the all important detail, the Euro has remained under downward pressure.
The crisis has also had a significant impact on inter-bank lending, which is a key source of short-term finance for the banks. Banks have become reluctant to lend to one another for fear of not getting their funds back in the event of a sovereign and bank default.
This has driven up wholesale money market interest rates and further worsened the availability of finance to businesses and individuals amplifying the chances of a recession.
Indeed the OECD this week said Germany was already in recession, and rating agencies are saying the sovereign credit ratings of all the Euro zone nations are at risk of downgrade.
Fearing complete paralysis in the financial markets the world’s leading central banks, led by the US Federal reserve, stepped in yesterday to increase their bilateral swap arrangements with the Fed slashing the interest rate it charges on special dollar liquidity from 100bp to 50bp.
The reaction in the markets was swift: the Euro and equity markets rallied as traders sensed the authorities were at last co-ordinating their efforts in an attempt to keep credit flowing.
However these moves, as welcome as they are, can only have a limited affect. The supply of liquidity to the banks has been improved, but the inter-bank money market needs to start functioning normally again.
Moreover, the sovereign credit crisis remains unresolved. Yesterday’s central bank action was a sticking plaster over a much deeper wound.
The Germans remain committed to treaty changes that they judge will prevent another crisis such as this ever happening again, and are pushing for closer fiscal union with a centralised budget watch dog with powers to punish countries that break the rules on spending and borrowing.
But all of these plans require detail and take time to implement, meanwhile the current crisis requires urgent action.
We judge yesterday’s rally is of limited longevity and once the impact of the move wears off, the Euro may resume its slide against the Dollar as traders refocus on the chances of the worst-case scenario of a Euro zone break up actually occurring.
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