The euro is likely to struggle anew in the upcoming week as markets remain fearful about sovereign debt issues in the peripheral euro zone economies, and investors are well-advised to be short the currency going into 2011.
A five-notch downgrade of Ireland by Moody's and budget warnings by the International Monetary Fund on Friday weighed on the currency and will continue to cloud the euro's near-term outlook.
An agreement by European Union leaders to set up a permanent mechanism from mid-2013 did nothing to assuage those fears. Investors were hoping for more aggressive solutions to address the region's fiscal crisis, such as increasing the European Financial Stability Facility or issuing joint European sovereign bonds.
"There are plenty of potential catalysts for the euro to go lower. And we might see the euro hit $1.26 over the next two weeks or so," said James Dailey, chief investment officer and senior portfolio manager at TEAM Asset Strategy Fund in Harrisburg, Pennsylvania. Dailey's firm manages assets of around $180 million.
Should the euro fall to $1.26, Dailey said he is looking to cover his portfolio's short positions.
On Friday, the euro slid to a two-week low at $1.3133 and was last at $1.3181, 0.4 percent lower on the day. On the week, the euro zone currency was down 0.2 percent, although for December, it is up 1.5 percent.
On the charts, immediate support for euro/dollar lies at $1.3104, the 200-day moving average. Below that level, $1.2970, the Dec. 1 low, looms.
In the options market, risk reversals, a measure of currency sentiment, remained skewed toward euro puts, or bets for a currency depreciation. On Friday, the one-month 25-delta risk reversals were at -2.375 vols, unchanged from the previous session.
To be fair, the option market's view on the euro has improved over recent sessions, although risk reversals on the euro are still way below the levels seen in mid-October, when sentiment on the currency was its most positive.
CitiFX, meanwhile, has put out another bearish call on the euro, adding a 15 percent short position in its overlay portfolio and cutting dollar shorts to 5 percent from 15 percent. Steven Englander, global head of FX strategy at Citi, calls this a "significant change" in the bank's positioning.
Over the medium-term, Englander believes the euro zone will be able to resolve its issues, but he says the next month may be a "bit rough."
"The lack of liquidity as year-end approaches and the difficulties in coming up with comprehensive solutions on sovereign debt make us prefer euro shorts to longs for the time being," Englander said.
In the United States, there is a slew of data due next week, all of which is expected to show the world's largest economy is growing, albeit at a modest pace.
Two economic indicators for November, durable goods orders and personal income/consumption, will help guide forecasts for fourth-quarter growth, with more positive news likely on the consumer side.
CIBC World Markets has recently upgraded its fourth-quarter U.S. growth forecast to 3 percent, with the downbeat November non-farm payrolls data looking increasingly like an outlier amid other positive signals.
These reports should keep a bid on the dollar and continue to push U.S. 10-year yields higher.
TEAM Strategy's Dailey thinks the back-up in bond yields is a reflection of the acceleration of U.S. growth, all supportive of the dollar. But he says U.S. Treasuries could rally next week as investors seek to "de-risk" their portfolios, but by 2011, yields could rise once again. He forecasts 10-year yields to rise to between 4 percent and 4.5 percent by end-2011.
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