Euro Erases Gains as Bailout Euphoria Wears Off

The U.S. Dollar is trading higher overnight against mostmajor Forex markets, buoyed by two major events: the inability of the EuropeanUnion’s rescue package to instill investor confidence in the Euro and the newsof the resignation of U.K. Prime Minister Gordon Brown. Both events are drivingtraders out of risky investments, triggering an increase in demand for lowerrisk currencies.

The U.S. Dollar is trading higher overnight against mostmajor Forex markets, buoyed by two major events: the inability of the EuropeanUnion’s rescue package to instill investor confidence in the Euro and the newsof the resignation of U.K. Prime Minister Gordon Brown. Both events are drivingtraders out of risky investments, triggering an increase in demand for lowerrisk currencies.

After a one day reprieve following the announcement of theEuropean Union’s $1 trillion bailout package, the Euro is once again in a freefall this morning, threatening to take out the recent bottom at 1.2518. Thehistoric announcement by the EU over the week-end failed to generate enoughinvestor confidence to support the Euro, but more importantly reaffirmed thatthe destiny of the Euro is clearly in the hands of the hedge funds and largetraders.

The fact that the Euro is trading sharply lower ahead of theNew Yorksession is a strong sign that the euphoria of the past 24-hours is over andthat reality has returned to the Forex markets. Simply stated, Monday’s tradingaction demonstrated that traders accepted the fact that the EU’s aid packagewas a short-term fix and that over the long-term the economic problems in theEuro Zone would continue to exist long after the new money was sucked into thefinancial system. The post-bailout package sell-off in the Euro is also servingas proof that the market doesn’t believe that a country solves a debt crisis byissuing more debt.

The rejection by the market of the rescue plan serves asnotice to the EU community that there is little doubt that the only way toavoid the spread of contaminated debt in the Euro Zone is to implement furtherausterity measures rather than pile debt upon debt. The overnight weakness inthe Euro is also a strong indication that the market is discounting theinevitable that the debt of Greece,Spain and Portugal isgetting very close to being declared “junk” by the credit rating services.

Besides the fear of contagion over the short-run, Euroinvestors are dealing with the real possibility that the bailout package willbe a drain on European economic growth. The implementation of the unprecedentedbailout package means that resources will be used to fill in “holes” in theeconomy rather than sow the seeds for future prosperity. Flooding the marketwith excess liquidity will force the European Central Bank to keep interestrates low for a longer period of time. As other major central banks begin towithdraw stimulus and hike interest rates, investors will shift investments outof the Euro Zone and into these higher yielding currencies putting additionalpressure on the Euro.

While Euro investors deal with contagion issues, BritishPound investors are wondering what happened to the government. The decision byU.K. Prime Minister Gordon Brown to quit has created disarray in the governmentjust 5 days after the recent election resulted in a hung parliament.

Speculators are selling the British Pound this morning whilethe three main political parties haggle over how to structure the newgovernment. At this time the Labour Party and the Conservative Party are tryingto gain control of the hung parliament. The main objective of the processtaking place at this time is to convince the Liberal Democrat party to throwits support to one of the two strongest parties.

British Pound traders are taking no chances at this timethat a solution will be reached soon. Instead they have decided to sell thecurrency now and ask questions later. Even if a government is created today,the U.K.’sfinancial woes are not expected to disappear. There is still the main issue ofhow to balance the budget and reduce the country’s debt load.

The longer it takes to form a government, the more impatienttraders will grow. This means that downside pressure is expected to continueuntil the new government issue is settled. Furthermore, the delay in producinga government could lead to a downgrade of the U.K.’s debt rating as the creditrating services will interpret this to mean that a solution to its debtproblems may be difficult to attain in the short-run.

Today, traders should watch for a reversal of the action onMonday. In other words, risk adverse traders are expected to sell higher riskassets while seeking shelter in the lower yielding currencies. Look fordownside pressure on the commodity-linked currencies. Overnight, traders aredriving the Australian Dollar, Canadian Dollar and New Zealand Dollar lower. Atthe same time, the lower yielding Japanese Yen is rising versus the U.S.Dollar.

James A. Hyerczyk has been actively involved in the futures markets since 1982. He has worked in various capacities within the futures industry from technical analyst to commodity trading advisor. Using W. D. Gann Theory as his core methodology, Mr. Hyerczyk incorporates combinations of pattern, price and time to develop his daily, weekly and monthly analysis. His firm, J.A.H. Research and Trading publishes The Forex Pattern Price Time Report... More

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