The euro looks vulnerable – is it finally heading for a bear market?

Money talks, so they say.

So today, we ignore the sound and fury of the European elections. We ignore the implications for the political careers of the some of the protagonists. And we ignore the chatter.

Instead, we look at what the money actually said.

What did the currency markets make of it all? And how can you profit from it?

The euro is the most vulnerable-looking major currency

Let’s look first at a chart of the pound and the euro against the dollar over the past week. The upper chart is the pound (black line). The lower chart is the euro (blue line).

GBP and EUR v USD in the last week

The first thing to note is that the pound is back where it was a week ago at $1.68. It had a tiny rally to $1.69 in the days leading up to the election, which it has since given back.

In short, the reaction of the pound to the ‘political earthquake’ was negligible.

But the euro was rather weaker against the dollar. Over the course of the last week, it has fallen by about a cent. And it has fallen by a similar amount against the pound.

This could be the start of something bigger.

Take a look at the ten-year chart of the euro against the dollar below. We can see the strong support from around $1.18 to $1.21, where I’ve drawn the red band.

You can see the early 2008 high at $1.60 and the sequence of lower highs ever since – where I have drawn the falling blue trend line.

EUR v USD since 2004

Over the past month, the euro broke above that line (where I have circled in red), but then reversed back below it. Some might see this as a ‘fake-out’ (in other words, it looked like it was going to break through to newer highs, but failed to do so).

Now that we’re back below that blue line, the implication is that we’re headed lower.

I notice that the euro has had a fairly regular price pattern against the dollar over the long term. The last three periods of appreciation have each lasted about a year, while the gains from late 2005 lasted just over two years.

The falls meanwhile are a bit shorter. The last one – from mid-2011 to mid-2012 – lasted about a year. The two prior to that were about six months.

Given that we’ve just had a year of bull market, the timing is right for another euro bear market to rear its head. The pricing (that blue line) is about right as well. And the geopolitical set-up – fallout from these elections, lots of parliamentary squabbling still to come as Nigel Farage and Marine Le Pen start declaiming away – looks good as well.

Then there’s the other side of the coin, the US dollar, which after a long period of sideways action could be getting set for a monster rally.

So, if there’s a trade to be taken away from today’s Money Morning, it would be to short the euro against the dollar. Do bear in mind that if you are thinking of doing this, you absolutely must manage your risk. All trades are risky, and shorting the euro can be a real ‘widow-maker’.

On the all-important risk management, there are several options to place your stop-loss. If you like them really tight, just above the blue line at, say, $1.38. You could go for just above the recent high at $1.40. $1.43 is another option – just above an obvious line of resistance at $1.42.

My first target is $1.34, then $1.28, then all the way back at that red band at $1.22.

We’ll see if I’m right, but I think a cyclical bear for the euro against the dollar is just ahead.

What about the pound?

As for the pound against the euro – well, sterling looks strong, as the chart below shows.

After a shoddy second half of 2012, it put in a strong double-bottom in 2013, and it’s had a strong run off that base, rising from €1.14 to €1.23.

We might slip back a little at €1.20. But over the next year I can see this one rising to test that 2012 high at around €1.29, where I have drawn the red band, and perhaps even to the top of that clear blue channel around €1.32.

GBP v EUR since 2004

It’s no surprise really. The problems of high unemployment across the continent remain.

The only growth Europe is experiencing is in regulation and in-fighting. There is the issue of the banking union. There is all sorts of political division – not only between left and right, but within the anti-Europe protest vote itself.

There’s the matter of Ukraine and Russia, and the soon-to-be-significant high-gas-price problem as Russia starts selling to China. And, to cap it all, I’m starting to read reports of a slowdown in Germany.

So, all in all, not a good time for the euro. Perhaps the European elections will end up mattering rather more over there than they will over here.

• Dominic Frisby’s latest book, Bitcoin – the Future of Money will be available soon. His first book, Life After The State, is available at Amazon. An audiobook version is available here.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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  • mikeT

    I agree with all that is said BUT…Anti-EU sentiment increases the possibility (small though I think it is) that peripheral countries (Spain, Portugal etc) might abandon the Euro because it is too strong to enable economic recovery. That means a stronger Euro because it will represent the core, relatively stronger economies esp Germany. Thoughts, anyone?

  • Warun Boofit

    I agree with most of the article but you forgot to add in the possibility of money printing as well which I think is probable within the next 12 months and this will devalue the Euro. We can see that France is a basket case already and the protectionist way its government are fending off GE from taking ALSTOM contrasts with the relatively hands off UK goverment handling of the Pfizer bid for Astra Zeneca. Europe is not a common open market , there is no chance to have UK companies buying up French/Spanish or German power utilities the way they have taken over UK companies but these policies backfire as the rest of the world sees the UK as a safer bet for investment. I look forward to UKIP/FN etc adding to the turmoil in Brussels, I see all these factors helping the pound to go higher and the demise of the Euro.