Excessive Volatlity Likely in Euro Next Week

The Euro started the week on the downside but quickly picked up strength as Euro Zone reports indicated the worst of the economic slowdown may be over.  Traders also regained confidence in the European Central Bank’s ability to gain control of interest rates. 

This all sounds good but next week Euro traders face the possibility of excessive volatility as the Treasury increases U.S. debt by $100 billion and speculators begin to wonder if there are any major U.S. financial institutions in trouble.

The week started on the downside for the Euro. Selling pressure was coming in pretty heavy as traders were still punishing the Euro because of the lack of confidence in the European Central Bank regarding the future of interest rates and the new asset buyback program.

Geithner and ZEW Report Help Stabilize Euro

Technical traders took over on April 20 and 21 as the Euro held tight to a .618 retracement of the 1.2456 to 1.3737 range at 1.2945. Friendly comments from U.S. Treasury Secretary Geithner along with a better than expected ZEW German investor confidence number helped stabilize the market and set up the support base for the ensuing rally.

The Euro traded in a wide range on April 22 while establishing support at 1.2884. The lower-low followed by the higher close triggered the reversal bottom which launched the start of a short-covering rally.

Euro Traders Regain Confidence in ECB

The Euro rallied on April 23 following the release of a better than forecast Index of European Services and Manufacturing Report. This news triggered a breakout rally to the upside and confirmed the reversal bottom at 1.2884. The ensuing rally picked up steam as market participants were now beginning to believe that the two bullish economic reports this week were helping to solidify the notion that the European Central Bank was going to keep its benchmark interest rate from falling below 1.0%. The rally erased the downside pressure from earlier in the week as any uncertainty regarding interest rate levels seemed to be rectified.

More gains were posted on April 24 as news that German business confidence rose from 26 year lows ignited a surge to the upside and fueled the thought that maybe the worst of the recession was over. Technically the Euro is still in a downtrend on the daily chart. The three day rally stalled near the .618 retracement level of the 1.3582 to 1.2884 range at 1.3315 and the 50% retracement level of the 1.3737 to 1.2884 range at 1.3311. This set-up created a double-resistance zone at 1.3311 to 1.3315. This resistance zone will be there on the opening next week. Breaking through these levels will be the key to sustaining the rally.

Brace Yourself for Volatility Next Week

Fundamentally traders will have to watch two events next week. The first is the three day Treasury auction. The size of the auction coupled with the recent weakness in the Treasuries is an indication that market participants will be asking for higher yields. This along with the huge increase in debt will most likely help buoy the Euro. The huge $100 billion increase in the U.S. deficit is causing traders to ask, how are we going to pay for this?

From now until May 4, Euro traders should watch for news regarding banks and stress tests. The news will probably be negative and the market will react by flocking to the U.S. Dollar while selling out of higher risk currencies like the Euro. I’m sure you noticed the break from the high in the Euro on Friday. Traders seemed to cringe a bit after the Fed said that the top 19 U.S. banks need to hold a “substantial” amount of capital above regulatory requirements. This comment opened the door as to what “substantial” means.

Traders will be looking at this report daily to try to figure out if there is a major U.S. financial institution on the brink of failure. The Obama Administration will try its best to keep the preliminary stress test reports secret until May 4 to prevent a run on a bank or excessive speculation in bank stocks but this shouldn’t stop the pundits and bloggers from trying to identify which bank may not make the cut. All it is going to take is a little fear to trigger an explosive rally in the U.S. Dollar.

Summing up everything that can take place next week, it looks as if there is a strong possibility of a volatile two-sided trade in the Euro. In the absence of negative news regarding the bank stress tests the Euro should rally but if negative news hits the banking sector, look out below.