Why Forex Traders Might be Wrong About the Euro

Jean-Claude Trichet, President of the European Central Bank, spoke Thursday morning. In his speech, he used his traditional "strong vigilance" phrase, which investors have interpreted to mean a forthcoming rate hike. Following that speech, the EUR/USD began a sharp sell-off, as currency traders may have abandoned the euro in favor of the dollar. The U.S. dollar index rallied roughly 0.46%. Are traders right to abandon the euro? Forex traders might be shifting out of the euro on fears that a rate hike will push the European Union into recession. A weaker European economy might mean a weaker European currency. However, that investment thesis fails to take into account several major global factors. Wednesday's release of the Federal Reserve's Beige Book indicates that U.S. economic growth has slowed. Jobs data has been worse than anticipated. Chairman Ben Bernanke has thus far declined to float the possibility of a third round of quantitative easing, though if the economy remains weak, a QE3 might be possible. Simultaneously, there is increasing evidence that emerging markets are due for a pullback: inflation has spiked in Turkey, perhaps indicative of an asset bubble; in China, it seems as though every day brings a story of a new fraudulent Chinese stock; in a global survey, FT Advisor reported that half of investors had serious concerns over potential overheating in emerging markets. While traders ought to price in the obvious risk factors evident in the euro (Greece), abandoning the currency on Trichet's remarks may be foolhardy. If emerging markets enter a recession, and the U.S. economy is trudging along at a snail's pace, the euro may be the most intelligent position investors could take. Thursday's dip could be a great buying opportunity. Action Items Bullish: Traders who believe that the euro will rally as investors return might want to consider the following trades:

• SPDR Barclays Capital International Treasury Bond ETF BWX is a long play on European bonds. EU bonds might do well if the euro rallies.
• WisdomTree Dreyfus Euro ETF EU is a pure long play on the euro. If the euro rallies, EU might do well.

Bearish: Traders who believe that a rate hike will doom the European economy, and hence its currency, may consider taking positions in the following:

• ProShares UltraShort Euro EUO is a short play on the euro. If the euro depreciates, EUO may rally like it has today.
• PowerShares DB US Dollar Bullish Index UUP is a long play on the U.S. dollar. If investors flee the euro, the dollar might benefit.

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