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Why the Euro is NOT a Buy

We’ve critically hit on (ad nauseam at times) the politicization of the Fed to keep rates low for an “exceptional and extended” period.  However, with Thursday’s decision by the Senate Finance Committee to vote in Bernanke for a second term now in the rear view and with the release of highly inflationary November US CPI and PPI numbers this week that even Bernanke won’t be allowed to ignore (+1.8% Y/Y and +2.7% Y/Y, respectively), we believe markets are increasingly pricing in expectations of a US rate hike.

As expectations for a hike move toward the near months we’ve already seen sharp impacts in the currency markets. In particular, the USD gained impressive upward momentum with the US Dollar Index trading positive for 5 of the last 6 day this week; and certainly yesterday’s monster move of +1% in the USDX contributes evidence that the Reflation TRADE is unwinding. US Financial (XLF) and Energy (XLE) stocks (proxies for inflation) are obvious examples of this.

As it relates to the Euro, increased bets that the Fed will hike and thereby reduce the spread between the US interest rate and the ECB’s 1% benchmark rate have begun to shift buyers away from the Euro. This week alone the EUR lost 2.3% versus the greenback. It’s lost -4.5% in the last month.

As we get more confirmation from the unwinding of the Reflation TRADE, we’ll look to take a more aggressive stance on global currencies. At times this year we’ve been short the US dollar via the etf UUP in our model portfolio. As it relates to the EUR-USD, the levels below suggest at the right price that we could get paired off, short the Euro, long the USD.  Stay tuned.

Matthew Hedrick
Analyst

Why the Euro is NOT a Buy - Euro1