We don’t usually talk about currencies here on Market History because we don’t trade currencies. We focus purely on investing in the S&P 500 index ETF’s. However, every once in a while there is a very good setup in the forex markets that we just have to take note of.
The Euro soared on April 24 when Macron and Le Pen won the first round. This is because it is pretty much guaranteed that Macron will beat Le Pen in the 2nd round of the French election. The Euro has risen to $1.1 since April 24, 2017.
However, the Euro faces many bearish factors throughout the rest of May and the next few months. Perhaps it will fall and close lower (monthly close) in May.
Strong bearish seasonality
We normally don’t look at monthly seasonality because it tends to be random. And the seasonality is usually not strong enough to pay attention to.
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However, the Euro has a very strong seasonal pattern (even though we cannot explain this seasonal pattern). May is one of the Euro’s weakest months. Here is a chart from Sentimentrader depicting this seasonality.
The Euro has gone down 10 times out of the last 12 years in May. The only reason why January is worse than May is because the Euro spiked in May 2009 while all other assets around the world were spiking. If you exclude that one fundamentally driven exception, then May would be the worst month of the year.
In addition, June isn’t much better for the Euro in terms of seasonality.
Sell the news of a Macron victory?
Seasonality on its own does not mean anything. Seasonality becomes much more powerful when you combine it with other indicators.
Right now the Euro has rallied in anticipation of a Macron victory on Sunday May 7’s French election. In other words, the Euro has front run this good news by a lot. So if Macron does win, perhaps the Euro won’t rise by much. The market has already priced in a Macron victory. Or perhaps the Euro will be flat for a few days on Macron’s victory, and then “sell the news”. Perhaps the Euro will fall next week. Who knows. But it’s unlikely that the Euro will soar again on round 2 of this French election trigger.
Commercial hedgers are extremely bearish on the Euro
In the currencies market, “commercial hedgers” are considered the smart money. It was revealed in the latest COT Report that hedgers are starting to short the Euro right now (because of their bearish outlook). Here is a chart from Sentimentrader.
*The red “bearish” line is 1 SD below the hedgers position’s 3 year moving average.
The Euro made a significant correction the last time the Euro’s hedgers position touched the red line. But what’s really interesting is that the Euro has consolidated in a tight $1.05 – $1.15 range from March 2015 to today. During this time, hedgers have gotten more and more bearish on the Euro! Hedgers tend to be large banks. Since banks have large position sizes, currency desks at banks tend to trade in anticipation of large price movements. They do not trade for tiny price fluctuations. Does this mean that the commercial hedgers think the Euro will fall significantly to $1 against the U.S. dollar or below? Perhaps.
Too many people are bullish
Right now, it seems as if almost everyone is bullish on the Euro. Many hedge funds on CNBC are saying that they’re buying the Euro while many traders that we know are also long the Euro.
Extremely bullish sentiment on its own is not a bearish sign. The market can continue to go up long after the masses are “extremely” bullish. What’s bearish is when sentiment is extremely bullish but the price isn’t rising a lot. You have to ask “if everyone is ‘bullish’, why isn’t the Euro going up a lot?” It usually means that a few big “smart money” players are heavily short the Euro in anticipation of a big decline.
The Euro has rallied less than 5 cents against the USD since April 10, 2017. If the Euro really was so bullish, it should have SOARED since then, especially considering the bullish potential of a Macron victory in the French elections. Instead, its rally has been very tepid. At the very least this is not a bullish sign.
The Eurozone’s economic data in the last 4 weeks has also been very good. If the Euro truly was in a healthy rally, it should have soared on this bullish economic data as well. It didn’t. This is another bearish sign.
We do not trade the Euro because we do not have a quantitative model for doing so. These are just some thoughts that you should take with a grain of salt.
But the bottom line is simple. The Euro faces a few significant headwinds in the next few months.