John Taylor Sees Tuesday As D-Day For European Currencies, Says America Is Headed For New Recession

John Taylor appeared earlier on the 2011 Reuters Investment Outlook Summit, and among various interesting things (namely another call for EUR-USD parity, and that he would "love to be owning gold right here"), he said that the US is imminently headed for another recession, a development that will boost the USD and weigh on commodities. Yet what is more interesting is that in his latest "Chairman's View", Taylor put down a specific date for the end of the recent recovery in European currencies: the date is tomorrow, the day of the Irish Budget decision, and also the day when Europe may see a coordinated effort for a bank run. Taylor also notes that "the narrowing of credit spreads between these countries and Germany is unlikely to persist for very long without further action by the European leaders." Hopefully the Eurozone meeting taking place right now will result in something more than just more hot air. For those who trade FX, Euro sov bonds, or are just generally interested in the views of the manager of the world's biggest FX hedge fund, we recreate his latest thoughts below.

The Recovery in the European Currencies Should End Tuesday
By John R Taylor/Jonathan Clark

The market took the European currencies strongly higher on Friday and used the weak US employment data as an excuse. The cycles were already calling for the recovery to last into Tuesday, although we didn’t expect the strength seen on Friday. In the near term the strength of the European currencies makes sense as it impacted the interest rate differential between Germany and the  US. It was the narrowing of the  short-term differential between November 4 and the start of last week that contributed to the weakness of the euro and the subsequent widening that contributed to its strength. However, the rebound in the single currency was also due to the belief that once again European leaders would band together to rescue any countries that lose market  confidence and are unable to float debt at reasonable interest rates. The markets should have been disappointed on Thursday that the ECB only extended its extraordinary loan program and bought Irish and Portuguese debt. The hope was the ECB would either announce a bold expansion of monetary efforts, but all they got was a slight of hand press conference and loud market noises for the ECB traders. It is confusing. Although the euro was strong, the Swiss franc was even stronger so EUR/CHF declined and this is usually a sign of risk aversion in Europe. EUR/PLN and EUR/HUF were falling most of the week and this is a sign of European optimism, but it stabilized on Friday. The Eurozone is treating the symptoms of Ireland, Spain, Portugal, Italy and Greece’s lack of competitiveness, but not the causes. This argues that the narrowing of credit spreads between these countries and Germany is unlikely to persist for very long without further action by the European leaders.

The more the European currencies rise into the high expected on Tuesday the more aggressive the next leg of the downmove will prove. The impact of bad US employment data was largely ignored by the US equity market. It won’t power the euro higher. We expect the EUR/USD to peak around 1.3470 (38.2% retracement from high in early November to the low last week). It should then turn lower and decline into the days surrounding the Christmas holiday. Provided 1.3470 holds on a closing basis the euro can still fall to new lows around 1.2625 around the end of the year.