EURO

The euro as a currency is the most complex in the world. The creation of the euro was
a tectonic event in world economic news. Other currencies reflect one unified economy,
whereas the euro reflects 13 economies comprising the Eurozone:
Belgium
Germany
Greece
Spain
France
Ireland
Italy
Luxembourg
The Netherlands
Austria
Portugal
Slovenia
Finland
When combined, the Eurozone economy presents a powerful part of world trade.
Table 7.4 snapshots the key measures of the regions, such as population, GDP, sectors
of production, and unemployment rate.
This increased level of complexity introduces more uncertainty on the currency’s behavior.
Managing to control the multiple economies of the Eurozone makes the mission
of the European Central Bank (ECB) one of the most challenging of all central banks. To
succeed, the policies of the ECB need to succeed in all of the member countries. Keep
in mind that this is not easy. Each country has its own domestic policies, and its own inflation rates. Events in any country can undermine, achieving the average inflation rate
that the ECB sets. The forex trader has to expect the unexpected in regard to the euro.
The personality of the Euro as a currency is based on which countries are the
Eurozone’s trading partners. We can observe these trading relationships in the Trade-
Weighted Index for the euro (refer to Table 7.5). The U.S. dollar has the greatest weight,
with the British pound and then the yen following. There is more than one trade-weighted
index that the trader should be aware of. For example, we also have a fairly new tradeweighted
index for the euro called the Dow Jones Euro Currency 5 Index (Table 7.6).
The DJEC5 places a greater weight on Japan and less weight on the United Kingdom. It
also includes Australia, which is ignored by the TWI. For those traders interested in the
mathematics behind this new index, the following equation is used to calculate it:
Index =
n

i=1
(pit × qit)
Dt
= Mt
Dt
where Dt = divisor at time t
Mt = the sum of component midprices multiplied by their respective weight
factors at time t
n = the number of currencies in the index
pit = the midprice of currency i at time t
qit = the weight factor of currency i at time t
Source: Dow Jones Indexes.com.

In any case, trading the euro in the absence of knowledge about which countries
the euro trades with will undoubtedly lead to misjudgments about the performance of
that currency. The importance of the euro as a currency reflects the fact that its trading
partners are global, and as a result the euro as a currency may become less dependent
on U.S. economic prospects. Traders have many choices of pairs to shape the trade. The
EURUSD pair is the most popular, followed by the EURJPY pair and the EURGBP pair.
The fundamental picture of euro performance at this point in time is that of sustained
strength. It has been probing trade-weighted highs, which reflects strong economic performance
in its member countries. The economic growth of the Eurozone has led to
interest rate increases by the European Central Bank to contain inflation near a 2 percent
level. This increase in rates has served to further strengthen the demand for the
currency. The ECB raised its benchmark interest rate seven consecutive times, from
2 percent in December 2005 to 4.0 percent now, and is in a position where it can order
up more rate increases in 2007 without squeezing growth. The issue for the Eurozone’s
future direction will significantly depend on whether its high interest rates will
contain inflation or fear of inflation and lead to market expectations of no further rate increases.
However, the Eurozone also faces a relatively high unemployment rate of nearly
8 percent.
If the currency continues to have strength against a weakening yen, the Eurozone
may face a slowdown on exports, of which Japan is an important trading partner (Figure
7.10), which would result in a slowdown in its economic performance. The trader should
carefully watch the EURJPY pair (Figure 7.11) if it presses on to new weekly and monthly
highs. Fundamental forces will kick in and provide the impetus for a sell-off.




By ABE COFNAS