To trend or not to trend?

Will ECB front loading, trigger a EUR/USD short squeeze?

Can the euro go lower, or is a short squeeze imminent as the latest political and macroeconomic developments are digested

Due to an expected shortage of liquidity in July and August, the ECB decided to front load their purchases of sovereign debt in May and June.

The news of this decision prompted a large sell off in the EUR/USD, with the single European currency experiencing its second biggest one-day fall in three and a half years, as the market reacted to the negative effect the extra bond purchases would have on the euro’s exchange rate to the U.S. dollar.

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The decision to front loaded purchases was taken based on the reduced expectations about bonds  availability in June and July. The expected bonds available for purchase in June were 26 billion euros, but the July net issuance was expected to turn negative, at minus 46 billion euros. So if bonds are not available for purchase, then the ECB cannot purchase them, hence their decision to front load purchases.

We are now in July, and the euro is still very weak, but a reversal could be just around the corner. With the ECB buying less debt in July and August due to front loading and the shortage of bonds offerings, the euro could be due for a correction. With fewer bond purchases taking place in July and August, the opposite effect of the recent sell off could be seen, and a short squeeze could be triggered.

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According to OANDA’s client positions at the time of writing this article, 54 percent of traders are shorting the euro against the U.S. dollar and 46 percent are long. This data is only from one broker, but I know a lot of traders take this information into account when placing their trades. We do have a slight imbalance between long and short positions, and although we may see a mini rally in euro Dollar, I do not think this imbalance will be enough to trigger a full blown short squeeze just yet.

The EUR/USD was sold off heavy last week, so I would want to see some profit taking before considering adding any new short positions.

The Greek political turmoil is is still weighing heavy on euro, but work on a third Greek bailout program is underway. So that will be something to watch out for also.

From a technical perspective, I believe the euro will test 1.08 again before any sustained move higher. On the chart below we can see that the EUR/USD tested support levels at 1.0818 on 3 occasions without breaking out. The level is getting weaker, and I believe another test will see it breached and 1.08 will be the next level of buying interest. If 1.08 is taken out, the next support level at 1.0650 will be the next target.

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