Risk and Reflation, Euros and Dollars

The euro has been tracking the U.S. stock market for months, as a follower of either risk aversion or risk appetite asset shifts. Friday and today have been no different. The euro gave up 250 pips in 3 hours before the U.S. market opened Friday, and today with GM bankruptcy rumblings and Treasury Secretary Geithner admitting that some banks would still need "large amounts" of assistance, the S&P 500 opened 25 points lower and the euro dropped below $1.32. In this way, whether you were an FX trader or an equities trader, you could easily play one by watching the other and using it for confirmation.

After the euro's breakout above $1.31 on the last FED meeting March 18th, the question became: Is the euro responding on fundamentals to U.S. debt production ala "quantitative easing" (printing money to buy assets), or is it still just a risk appetite trade because "extraordinary liquidity" means a reflation of all assets?

Remember when the FED first took us to effective zero rates in early December? That "all-in" bomb blew up the dollar and sent the euro nearly 20-cents higher in less than two weeks. Then the euro quickly gave it all back in what looked like a failed attempt to regain its status as the currency-in-waiting for the reserve-of-choice spot. Testing the support at $1.25 and following U.S. equities higher gave the euro some revived respect, but it still looked like they were joined at the hip, more like siblings than distinct asset classes.

So the question remains whether the euro is just a proxy for U.S. financial stability, or if there are strong fundamental reasons to sell dollars and buy euros. To many, this may be the same question. Either way, investors and traders know that "so goes the U.S., so goes Europe"-to say nothing of the EU's internal problems with meshing the fiscal and monetary policies of 16 different economies and sovereign nations.

The test for the euro this week is the $1.31 level. Many buyers will come in here for sure. And this Thursday offers some potential fireworks in the form an ECB policy meeting and the beginning of the G-20 summit. The long-term test for the euro is "if and when" it ever decouples from the U.S. risk/reflation trade and moves to its own tune.

Kevin Cook, host of Mark2Market at ONN.tv

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