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Trade Alert: Short Euro currency Based
on trading activity and reports,
the following markets The spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate has reached an historically high price and presented an opportunity to trade this spread from the short side. Here's what we have observed: The Euro currency/Swiss franc cross rate is currently testing a major Fibonacci resistance level. (The Euro currency/Swiss franc cross rate looks at the ratio between the Euro currency and the Swiss franc. It is calculated by dividing the price of the Euro currency by the price of the Swiss franc). Since the Euro currency futures began trading in May of 1998, the highest point of the cross rate (on a weekly closing basis) was at 1.6934 in June of 1998 while the lowest point of the cross rate (on a closing basis) was at 1.4392 in September of 2001. A Fibonacci .618 retracement of the decline between these two historic levels would put major technical resistance on the cross rate at 1.5963...on Thursday, December 21st the cross rate was trading right there at 1.5966.
The spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate has reached an all-time high. (The spread is the price difference between the Euro currency/US dollar rate and the Swiss franc/US dollar rate). On a weekly closing basis, the spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate catapulted far above the old historic highs. Previously, the highest premiums that the Euro currency has had against the Swiss franc was .4761 (just over forty-seven and a half cents) in March 2005 and .4762 (just over forty-seven and a half cents) in December 2004. Before that, the 1998 high of .4679 (just under forty-seven cents) marked a major resistance area. Just this last week, the spread broke these old highs by nearly two cents and traded to a new record high of .4951 (about forty-nine and a half cents).
The spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate is overvalued when compared to just the Euro currency/US dollar rate. When the Euro peaked at what was then a new all-time weekly closing high of 1.3558 against the dollar during the last trading week of 2004, the Euro currency - Swiss franc spread closed at .4762. When the Euro peaked at a weekly closing high of 1.3455 against the dollar during March of 2005, the Euro currency - Swiss franc spread closed at .4761. With the current close of 1.3228 on Thursday, December 21st the Euro currency futures contract is over two cents and three cents below the 2004 and 2005 peak highs while the spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate is almost a two cents above the 2004 and 2005 highs. By historical standards, we assume that either the Euro currency is really undervalued or the spread is way overvalued.
The spread between the Euro currency and the Swiss franc may possibly be overvalued when compared to the spread between the interest rates of the European Central Bank and the Swiss National Bank. The current interest rate set by the European Central Bank (ECB) is 3.50% and the current interest rate set by the Swiss National Bank (SNB) is 2.00%. Therefore, the ECB rate is a good 1.50% higher than the SNB rate. On the surface, it stands to reason that the Euro currency should then be out-performing the Swiss franc as investors have more incentive to hold a currency that pays higher interest...right? Not so fast! Recent history shows that this interest differential is not as correlated to the currency spread as one would think. Look at the spread between the ECB rate and the SNB rate by comparing the spread on the spot futures markets - the 3-month EURIBOR rate vs. the 3-month EUROSwiss rate. (The 3-month EURIBOR rate futures contract is based on the Euribor Offered Rate for three month Euro deposits and the 3-month EUROSwiss rate is based on the British Bankers' Association London Interbank Offered Rate for three month Euroswiss franc deposits). The last time the implied interest rate on the 3-month EURIBOR rate had this much premium over the implied interest rate on the 3-month EUROSwiss rate was during the first five months of 2004. In that same timeframe, the spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate has traded to a high price of .4645 (about forty-six and a half cents) and a low price of .4153 (about forty-one and a half cents). While the spread between the 3-month EURIBOR rate and the 3-month EUROSwiss rate is now near that same level again, the spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate is trading significantly higher at an all-time high of .4951 (about forty-nine and a half cents). However, the correlation between the spread of the two currencies and the spread of the two STIRs (Short-Term Interest Rates) is not as strong as many may believe. Over the last few years there have been several times when these two different spreads trended in the same direction, there have been several times when these two different spreads trended in the opposite direction, and there have even been times when one of these spreads was in a strong trending mode while the other spread was confined to a non-trending choppy environment. The bottom line is this: The fact that the ECB interest rate has a good premium over the SNB interest rate does not mean that the currency spread will continue to move higher. On an absolute basis of comparing one spread to another, the currency spread is historically much higher than normal.
The spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate is now in a seasonal time frame where it could very well establish the high or low for the entire year. Looking at a small time window of the last trading week of December thru the first two trading weeks of January, we can observe that this spread has frequently made an important high or low that stayed in place for at least an entire year. In the eight full years that the Euro currency futures contract has been trading, the spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate has made it's high or low for the entire year (on a daily closing basis) 6 out of 8 times between the last five trading days of December and the first ten trading days of January. The years 2002 and 2004 were the only two that did not fit this criteria. However, in 2002 the spread made a high on the first trading day of the year that was not broken until May 28th! A significant high in 2004 was not made until February 17th and was finally broken in mid-December. There are at least five technical signals that we will use to short this spread: 1.) A close below the 18-day Moving Average. The 18-day Moving Average has moved higher every single day since October 25th. The spread between the Euro currency/US dollar rate and the Swiss franc/US dollar rate has closed above the 18-day Moving Average every day for the last two months as well. A close below the 18-day Moving Average, or even a decline in the 18-day Moving Average itself, could signal that the rally has lost momentum and that the trend has changed on this spread.
2.) A break below a series of important lows on the daily chart. The October daily closing low for the March Euro currency - Swiss franc spread was .4632 (about forty-six and one-third of a cent), the September daily closing low was .4624 (forty-six and a quarter cent), the August daily closing low was .4640 (just under forty-six and a half cents). Coincidentally, these lows are confluent with a daily Fibonacci .618 retracement at .4660 (forty-six and a half cents). The Fibonacci retracement was calculated between the June daily closing low of .4464 (about forty-four and two-thirds of a cent) and the current contract's daily closing high of .4951 (about forty-nine and a half cents). If the spread cannot establish support in this area it may be doomed to slide further. 3.) A close below the weekly 18-bar Moving Average. The 18-bar Moving Average has worked well for identifying the macro-trend direction for this spread on the weekly chart. A simple strategy of buying on a close above the weekly 18-bar Moving Average and selling on a close below the weekly 18-bar Moving Average has correctly signaled the change in the direction of the trend for multiple weeks/months at a time. The last time this spread crossed over the weekly 18-bar Moving Average was during the first week of 2006 when it gave a buy signal...it has stayed above this Moving Average since then!
4.) A change in the weekly up trend pattern of higher highs and higher lows. Ever since the spread established a multi-month weekly closing low of .4081 (just over forty and three-quarters of a cent) in November 2005, there has only been two different times when this spread has broken a previous weekly correction low by more than two ticks. (We are defining the weekly correction low as the lowest negative weekly close between two positive weekly closes). Therefore, these weekly correction lows are important technical support areas. A violation of these support levels could indicate that the spread is trending lower and accelerate the decline. 5.) An out-sized price correction on the weekly chart. During the current multi-month run between weekly closing low of .4081 (just over forty and three-quarters of a cent) in November 2005 and the current weekly all-time closing high of .4949 (forty-nine and a half cents) in November 2006, there have been fifteen different corrections. (We are defining a correction as a single week or an uninterrupted series of weeks with a negative weekly close located between two positive weekly closes). Of these fifteen corrections, eight of them were between thirty-five points and fifty-five points in size while only two of these corrections were greater than fifty-five points. Because of this, we view a correction greater than fifty-five points in size to be abnormal for this bull run. An out-sized correction may indicate that the trend has reversed. We could use any one of the above technical signals (or even a combination of them) to generate an entry recommendation. Additionally, we may also recommend increasing the position size of this spread as more technical signals are triggered. These signals could occur at any time so traders need to stay vigilant to monitor this spread. Traders need to be well capitalized to hold a currency spread position as well. If you are interested in participating in the Euro currency - Swiss franc spread trade, stay current with the Trade Alert emails. Disclaimer: There is risk of loss in all commodity trading. The data contained are believed to be reliable, but have not been independently verified by Pearce Financial. Accordingly, such data cannot be guaranteed as to reliability, accuracy, or completeness, and as such are subject to change without notice. Pearce Financial will not be responsible for any indirect, compensatory, or consequential damages, including loss of profits which may result from reliance on this data. Pearce Financial and/or its Principals and employees may or may not follow strictly any or all of the trading recommendations contained herein. The risk of trading futures and options can be substantial. Each investor must consider whether this is a suitable investment. Past performance is not indicative of future results.
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