Wednesday, January 20, 2010

Euro Breakdown

We’ve been watching with great interest, as have a lot of other investors and observers, the behavior of the euro over the past several weeks. It’s fallen rather quickly from $1.51 to $1.41 in that time. Today, it fell decisively through its 200-day moving average, which is widely watched as a longer-term trend indicator. The drop has largely been blamed on growing economic problems in that region, particularly in Greece, which is scrambling to try and repair its tattered public finances. The potential ramifications for the other eurozone countries, depending on how the Greece situation is ultimately resolved, has reached the point that many are starting to question the longer-term viability of that monetary union, and the euro as a common currency.

Why is this important to us? Well, the direction of the U.S. dollar is near the top of our list of things to watch in 2010. One of the key questions is whether it made an important bottom in 2008, when it rallied during the flight to safety caused by the financial crisis. Although it sold off again in 2009, it held above the 2008 lows, and has recently been rallying. We’ve been of the opinion that the structural headwinds facing the U.S. economy – bloated debt levels, large budget deficits, and high unemployment – would cause the dollar to resume its decline and eventually make new lows. But currencies are largely a relative game, and the severity of the problems faced by the other major industrialized economies (i.e., Europe and Japan) is causing us to reassess our view, and wonder if the greenback might continue to benefit from simply being the lesser evil.

Euro with 200-day moving average (blue line)