The Erosion of the Euro Currency

The euro is the world’s second-leading reserve currency behind the US dollar. On May 18, 2022, I wrote about the euro currency on Barchart. In that article, I wrote, “We are likely to see euro-US dollar parity over the coming weeks and months and a continuation of the trend of lower highs and lower lows in the euro currency.” It took three months for the currency relationship to probe below parity. After a bounce to another in a long series of lower highs, on August 31, the euro was worth less than a US dollar. 

Currency trends can last for long periods. The next level of technical support in the relationship between the world’s two leading reserve currencies is significantly below the current level. Relief rallies in the euro could be the perfect time to consider the short-term ProShares UltraShort Euro product (EUO).

The euro has been on a one-way path lower since January 2021

In early January 2021, the euro peaked at $1.2349 against the US dollar.

As the chart highlights, the euro has made lower highs and lower lows since the January 2021 high. The euro fell to a low of $0.99007 in August and was hovering around the $1 level on August 31. 

The October 2000 low is the next downside target

The last time the euro traded below parity was two decades ago, in 2002. If the downtrend continues, the next target is substantially below the $1 level. 

The long-term chart dating back to the early 1970s, long before the euro became Europe’s currency, shows the next target and technical support level sits at $0.8230, the October 2000 low. The euro currency remains below the January 2017 $1.03405 low, the support level the currency pair broke below in July 2022. 

Markets rarely move in straight lines- Currencies trend for long periods

Currencies are less volatile than many other assets because governments manage exchange rates to maintain stability. Cross-border payments are critical for the global financial system, which makes stable exchange rates a crucial factor for governments and international companies. Reserve currencies achieve that position because of their low-price variance with few price spikes higher or lower.

Government manipulation and intervention maintain price stability, so exchange rates rarely experience severe price appreciation or depreciation. Price changes tend to be slow and steady, with lots of backing and filling action. However, trends can last for extended periods. A bullish trend in the euro versus the US dollar exchange rate rose from October 2000 until July 2008, when the euro peaked at an all-time $1.60380 high against the dollar. The trend lower began in 2008 and continues in August 2022. After trending higher for twenty-eight years, the euro has gone the other way over the past fourteen years. 

Selling rallies could be the optimal approach to the euro as geopolitics weigh on the European currency

The trend is always your best friend in markets across all asset classes. In currencies, trends can last for years, if not decades. As the euro versus the dollar is in a bearish trend in late August 2022, selling rallies when the euro recovers could be the optimal approach to the foreign currency relationship. Two crucial factors support a higher dollar and lower euro:

• The trend of rising US interest rates supports the dollar versus the euro in 2022. The Fed is committed to battling inflation with monetary policy. Since interest rate differentials are one of the leading factors for the strength or weakness in currency pairs, rising US dollar interest rates support the current bearish trend in the euro currency. 
• Russia’s invasion of Ukraine caused the first major war in Europe since WW II. Sanctions on Russia and Russian retaliation against countries supporting Ukraine weigh on Europe’s economy, causing a weakening euro currency against other world foreign exchange instruments, including the US dollar. 

While the bearish technical trend has continued over the past fourteen years, fundamentals in 2022 point to a continuation of the lower path of least resistance of the euro versus the dollar. Each time the euro has recovered has been a selling opportunity in the currency pair. 

The EUO is a leveraged tool for shorting the euro against the US dollar 

The most direct routes for a risk position in the currency market are via the over-the-counter foreign exchange market or the futures contracts that trade on international exchanges.

A short-term vehicle for those looking to short the euro against the US dollar when the euro recovers is the ProShares UltraShort Euro product (EUO). At the $33.10 level on August 31, EUO had over $85 million in assets under management. The ETF trades an average of 113,450 shares daily and charges a 0.95% management fee. The product looks to deliver twice the percentage move in the euro versus the US dollar on the downside. 

The euro moved from $1.03675 on August 10 to $0.99007 on August 23, a 4.5% decline. 

Over the same period, the EUO ETF moved from $31.07 to $34.07 per share, or 9.6% higher, delivering over twice the percentage move on the downside in the euro. The EUO has two drawbacks:

• The EUO is a short-term tool that magnifies the percentage price action in the currency relationship. The price of the leverage is time decay. If the euro moves higher against the US dollar or remains stable, the EUO product will lose value.
• EUO only trades during the hours when the US stock market is operating. Currencies trade around the clock. The ETF may miss any significant price moves when the US stock market is not open for trading.

The trend is always your best friend in markets, and it remains lower in the euro currency. Selling on any recovery has been the best approach for the past fourteen years and will likely continue as technical and fundamental factors point to a lower path of least resistance for the European currency. 

• Stocks Mixed as Market Sentiment Remains Cautious
• Dollar Slips on Strength in EUR/USD
• Stocks Decline as T-note Yields Climb on Strong U.S. Economic News
• Dollar Gains as T-Note Yields Rise