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The Euro - How Low Can it Go?

May 14, 2012
Ron DeLegge

Two bailout funds, several political changes, and lots of promises later and the eurozone still finds itself heading toward the point of no return. How much further can the euro fall?

After three years of sharply rising, the stock market (NYSEArca: SCHB) finally woke up and remembered that Europe’s sovereign debt crisis isn’t going away.

High risk categories like emerging market stocks (NYSEArca: EEM) and European banks (NYSEArca: EUFN) have sold off and the euro is on the verge of traveling below its yearly low. Is this the beginning of a new bear market for the euro and where is the bottom? 

Resilient, but not Immune
Over the past two years, the euro, as tracked by the Euro CurrencyShares (NYSEArca: FXE) has posted modest losses of -2.92% in 2011 and -6.87% in 2010.

Some people convinced themselves the euro’s relative strength, despite its massive problems, was the sign of a resilient currency and that its debt problems were only a temporary glitch. As a result, the euro raked in a lot of suckers.

The ETF Profit Strategy Newsletter observed this trend way back in mid-2011 by saying, “Managers for sovereign foreign reserves have been dropping exposure to the U.S. dollar and adding euros. China pledged its cooperation to keep buying euro-denominated debt. Put another way, buyers have been enthusiastically exchanging exposure from one troubled currency to another.” Since then, “well-heeled” and “informed” investors have gotten sucker punched by the euro’s fall from 1.44 to 1.27.

A Problem with Many Faces
The latest euro selloff began on May 1 and was triggered, in part, by political changes in France and Greece – which are already undermining austerity measures. 

As struggling Eurozone countries try to close the gap on budget deficits, they’ve also been hit with a vicious cycle of credit downgrades. This in turn has forced many European banks (NYSEArca: VGK) to cut their exposure to sovereign debt in the region, causing even more funding problems for Eurozone governments.

While credit ratings have proven to be more symbolic than accurate, we can’t ignore them completely. Europe’s sovereign nations - from the strongest to the weakest - are caught in a relentless cycle of declining creditworthiness. It’s analogous to the pull of a strong magnetic field and escaping is difficult.    

Bailout Funds Keep Growing
Here’s another ominous trend for Europe: its bailout funds keep getting larger and larger.

The European Financial Stability Facility (EFSF) was created in May 2010 as a bailout vehicle for Ireland, Portugal, and Greece. Although 440 billion euros was initially pledged, leaders belatedly realized more money was needed to keep the fire from spreading. (As a side note, the EFSF’s creditworthiness and muscle was cut in January 2012 following the France’s credit rating cut. Beware of bailout funds without punch.)

The EFSF’s shortcomings paved the way for the European Stability Mechanism (ESM), which was added as another backstop. In March, Eurozone finance ministers promised 500 billion euros from this permanent bailout fund. The ESM has been described as Europe’s version of the International Monetary Fund.

Although Europe’s bailout funds have soared to roughly 800 billion euros, it’s done little to cut debt, reduce unemployment, and grow the economy.

Seeing through the Fog
Throughout Europe’s crisis, the media has contributed to the public’s confusion, by repeating incorrect facts coming from Europe’s leaders. Here’s a sample of headlines over the past six months:    

“U.S. Notes Europe’s Progress in Easing its Debt Crisis” – The New York Times
“Leaders Say Euro Rescue on Track” – Spiegel Online International
“Geithner: European Debt Crisis is Easing” – CBS Moneywatch
“Merkel Sees Fiscal Pact Progress” – The Irish Times

Meanwhile, the ETF Profit Strategy newsletter has remained very clear about how to trade the euro. In our Weekly ETF Picks going back to late last year we said, “Use strength in the euro to add short positions. The possibility of major overnight news from Europe - either the collapse or massive bailout of a major bank or several, or a eurozone breakup with members leaving or being booted - are very high right now.”

The ETF Profit Strategy Newsletter identifies key support levels for the euro along with buy/sell recommendations. These levels – once broken – will foreshadow lower prices.

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