Euro Retracements

As the Euro has shed six cents over the past seven sessions, two main forces have been at work. The primary one is, arguably, the developments in the euro area. After an extended flash crash that saw German 10-Year yields jump (from 5 bp on April 17 to almost 80 bp in the first half of May), they have come back off (53 bp Tuesday). The ECB confirmed what many had suspected. Namely, that the ECB will expedite its bond purchases ahead of the thinner summer markets.

Meanwhile, the situation in Greece is becoming more desperate. The government, of course is still spending money, but is falling deeper in arrears to its suppliers as it hoards cash so it can repay the IMF. It recently had to borrow from its reserve account at the IMF so it could make the debt payment to the very same IMF. These machinations are taking a greater toll on the economy and the Greek banks, which still appear to be bleeding deposits.

European officials talk tough and explain how the eurozone is better prepared to deal with Greece than it was in 2010-2012. While no doubt this is true, it is beside the point. As the Greek tensions escalate, contagion is still evident. Over the past week, as Germany's 10-year bund yield has slipped 5 bp, Italy and Spain's benchmark yields have risen 13 and 11 bp respectively. Much of it took place Tuesday. Although the electoral successes of the anti-austerity Podemos in Spain's weekend local elections may have weighed on sentiment, Spanish bonds have not under-performed Italian bonds Tuesday. Under a Grexit, the EMU would be shown to be reversible and investors could very well demand a risk premium.

The second factor that has weighed on the euro is better news from the US. The economic data suggests that Q2 is indeed recovering from what looks like another contraction in Q1. The weakness in the March non-farm payroll report was a bit of a fluke. April employment bounced back and the four-week average of weekly initial jobless claims made new cyclical lows. Top Fed officials have made it clear that they still anticipate the opportunity to hike rates later this year.

With this backdrop, let's look at the euro's price action. The euro's low so far this year was recorded on March 16 just below $1.0460. It retested the low on April 13 near $1.0520. The euro rose to a high a little below $1.1470 on May 15. The Great Graphic, created on Bloomberg, shows the Fibonacci retracements of the 2-month euro rally.

Based on the rally from the March 16 low, the 61.8% retracement is about $1.0845. A case can be made though that the retracement should be from the April 13 low. In that case, the 61.8% retracement is a little above $1.0882, which has been violated in North America Tuesday.

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Below the $1.0845 area, chartists see support in the $1.0680-$1.0720 area from previous congestion. In addition, a trend line drawn off the March and April lows comes in near $1.06 at the end of the week and $1.0620 on June 5 when the next non-farm payroll report is released.

The RSI has edged below 40. A couple of days before the March low was recorded it was near 15. The MACD's crossed lower about a week ago. The pace of the euro's sell-off, though has been very sharp, and the euro is trading below its lower Bollinger® Band (~$1.0910). It is difficult to talk about meaningful nearby resistance, but on ideas that the euro will not resurface above the $1.1000-20 area, look for short-term traders to sell into a bounce that could extend toward $1.0950.

Written By: Marc Chandler