The Euro's Unhappy Anniversary

 | Jan 03, 2012 | 2:30 PM EST  | Comments
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This article previously appeared on RealMoney Pro.

Here we stand, just two days after the 10th anniversary of the introduction of the euro, which became legal tender on Jan. 1, 2002. A decade later, the battered currency is newsworthy for all the wrong reasons, and the net euro short position is at its all-time high. While traders seem to be betting on the imminent collapse of the common currency, there are some very good reasons to avoid initiating short positions in the euro as we enter 2012.

First and foremost, there is no question that the short euro trade is a crowded one. Here are the net positions of a variety of currencies vs. the U.S. dollar; the euro is visible at the lower right corner of the chart, indicating a net short position of nearly 128,000 contracts according to the latest data from the CFTC.

Net Positions Held Measured in Futures Contracts
Source: Tradingfloor.com

Since traders are so overwhelmingly negative on the euro, it is ripe for a short-covering rally. That's reason enough to avoid shorting it right now, but what about later in the year? What factors will hang above the heads of euro shorts, threatening to create a rally in this unloved by still viable currency? What could be the spark that eventually lights this dry kindling ablaze?

There are numerous possibilities, but here's one that caught my eye: According to a report released on Monday by the Center for Economics and Business Research (CEBR), there is a 60% probability that at least one country will leave the euro zone this year. From Bloomberg:

 "It is not a done deal yet -- we are only forecasting a 60% probability -- but our forecast is that by the end of the year, at least one country (and probably more) will leave."

The CEBR pegged the likelihood of a eurozone breakup over the next 10 years at 99%. While we have all been inundated with prognostications over the past week, making it easier to turn a deaf ear to such a prediction, I would take heed of the CEBR's warning. The think tank didn't list likely candidates for an exit, but Greece is at the top of my list.

What would be the best way for Greece to get its economy moving again? Take a look at a sampling of yesterday's Markit.com PMI survey, which gave the following results for the eurozone countries. Any reading below 50 indicates contraction in the manufacturing sector:

Eurozone: 46.9

Germany: 48.4

France: 48.9

Italy: 44.3

Spain: 43.7

Greece: 42.0

It's clear that manufacturing isn't going to pull Greece out of its economic malaise. In order to stimulate Greece's economy, it will be necessary to boost tourism, which accounts for 15% of the country's GDP. If Greece drops the euro and switches to a devalued Drachma, that would stimulate its tourism business and create job growth.

There would be many unknown implications (would existing Greek bonds be redeemable in euro or Drachmae?), but removing one of the weak links from the chain would be a positive for the remaining members of the European Monetary Union, and for the currency. While removing Greece from the eurozone would not solve the sovereign debt crisis, the remaining monetary union would benefit from its absence.

In addition to the above, another reason to avoid shorting the euro is technical. From my article on Dec 13, The Euro That Stole Christmas:  "A crude but often effective method, the ABCD pattern, suggests a target of approximately 1.2850 for euro."

The euro dropped to 1.2857 on Dec. 29, just 7 pips (hundredths of a penny) above 1.2850. Now that the ABCD pattern has been completed, there may be less enthusiasm among technically oriented traders for the initiation of new short positions under 1.30.

So when you hear the gloom-and-doom projections about euro falling to parity against the dollar, or when pundits speak of the imminent demise of the eurozone, keep in mind that a variety of scenarios exist that could result in a stronger European currency. Despite the prevailing negativity surrounding the euro, it just might surprise us in 2012.

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