Updating Our Favorite Short...The Euro

  by Kevin Pendley

When is good news really bad news? When the market refuses to catch the ball on the good news and run. That's what happened Thursday when Eurozone economic data came in better-than-expected. Just take a gander at these highlights: 

• Eurozone GDP for the Q1 ... +0.7% versus the forecast for +0.2%.
• Eurozone GDP annualized rate ... +2.2% versus the forecast for +1.9%.
• Eurozone inflation edged lower for the month of April ... 3.3% versus 3.6% in March.
• Eurozene core inflation dipped to +2.4%, down from +2.7%.

Strong growth and lower inflation is pretty much the nirvana of currency market bulls, and although the euro staged a mild bounce after the data, the move was relatively tame and lacked staying power, as the euro gave back all those gains at various times during the U.S. trading session Thursday. Within the Eurozone GDP, German growth was reported at +1.5% quarter over quarter, the strongest rate in 10 years. However, there is a prediction among economists that Eurozone growth will taper off sharply as the year progresses, which accounts for some of the muted response to the GDP surprise.

The annualized GDP rate for the U.S. came in recently at +0.6%, which actually was a very good sign for the greenback and for the U.S. economy in general as there were fears that GDP could sink into "recession" territory at a negative number (the forecast was for a meager +0.2% rise). In addition, inflation data for the United States as seen through the Consumer Price Index was reported this week. The CPI headline figure was at 0.2%, with the "core" rate that excludes food and energy prices at 0.1%, both slightly below forecast. So, although growth remains an issue in the United States, inflation seems relatively tame (almost ridiculously tame considering a recent spike in gasoline prices). 

But more than picking apart the numbers, the real key here is that euro/dollar levels were unable to generate a decisive upside breakout on the good news this week. The pair is oversold on daily momentum readings after shedding 531 pips, or 3.3%, from the late April peak and a recovery rally off surprisingly positive economic news would not have been a shock. That said, the euro was basically stuck in the middle of the recent range after the GDP and inflation reports overnight Thursday. 

Some of the sharpest hedge fund traders of all time consider a contrarian move to the news one of the most powerful trading signals you can find. In a way, it goes along with the old trader saying, "Buy the rumor, sell the fact." In this case, it seems to fit quite nicely with euro/dollar shorts, despite the oversold momentum levels. 

Within the euro spectrum, it also seems worthwhile to update progress on some of our trade recommendations. The short euro/dollar strategy from late April continues to shine, as does the short euro/Canada trade from last week. However, the euro/yen trade rallied to trigger our profit protective stop last week and was closed out with a very meager gain of +0.12%. I'm a big proponent of protecting profits when the market turns, and hopefully some of you were able to exit the euro/yen short at a better level. At its peak return a few days ago the trade had a profit of +1.8% before the market turned. 

I still like the short euro/yen trade, and I'm recommending that the position be re-entered at 162.40 (which is the current level as I write this column), with stops at 163.01. As you can see by the attached chart this cross is back at a short-term resistance area with the highs from early May and the 20-day moving average, and still looks top-heavy long term.

Kevin Pendley has been involved in financial and commodity markets for two decades, including more than 15 years with Knight-Ridder Financial News/BridgeNews.  In addition to his work at 4xAdviser.com Weekly, he is a contributor at SmallCapInvestor.com where he writes a weekly technical analysis column on the Russell 2000.