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How Low Can the Euro Go?

The euro dropped to an 11-month low today, leading bargain hunters to wonder if now is the time to buy the battered currency.

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Despite tumbling Tuesday and Wednesday to its January low of about $1.29, analysts say they expect the euro to keep on falling through the end of the year. “The fundamental outlook for the euro is getting worse by the minute,” says David Song, a currency analyst for DailyFX.com. It’s likely to close the year below that January low, Song says.

Throughout the ongoing crisis, the euro has continued to trade above the average value it’s held since it was created. Since inception, the euro’s average level has been about $1.20 — that’s essentially the exchange rate set when it was created, and still roughly its fair value by measures of purchasing power parity. Last year, in the first round of the sovereign debt crisis, the euro fell to about $1.19, and it’s entirely possible it will fall past that low as the crisis continues to deepen, says Camilla Sutton, the chief currency strategist at Scotiabank.

Still, analysts say traders looking to short the euro should be braced for short-term rallies. Between Tuesday and Wednesday, DailyFX saw a 40% increase in the number of retail traders shorting the euro. “It seems as though retail traders are chasing these moves now, and that’s why we’re thinking we could see a small bounce before it heads lower,” because retail traders’ positions tend to be wrong, Song says. Traders could consider waiting for a bounce to short the currency from a higher level, he says.

The fact that market sentiment is so overwhelmingly against the euro actually creates more risk, says Tommy Molloy, the head of trading at FX Solutions. “Virtually all market-watchers are short the euro,” Molloy says. That means there’s a risk of a “short squeeze,” Molloy says, in which a small move up becomes a big rally because traders who are short have to close their positions, pushing the currency higher. “Given the market’s very one-sided bias, it behooves traders who have money to spend to buy some protection, perhaps via the options market,” he says. One possibility would be a one-to-three month call option that would give a trader the right to buy the euro at, say, $1.35. That option would serve as a hedge against an unexpected rally.


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