Three Currency Pairs to Trade for a Weak Global Economy

There has been a lot of weakness in growth currencies recently, largely due to fears of a continued global slowdown. Also, a weak Euro has been one of the biggest consequences of the deflating European economy. The EUR/USD Dollar cross rate has been extremely weak over the last 10 months, trading down from a high of near 1.49 last summer to today's level of 1.2955, as of writing. The low earlier this year was about 1.2850, so we are right near the bottom of that multi-year range. There will need to be a significant event that drives the pair downwards to break this massive resistance, and that event may not be so far off.

We have a serious crisis in Europe that has been brewing for more than a decade now, but the focus of the crisis is really now on Spain. Yes, the Greek elections pose a risk to Greece staying in the EMU, but Greece is miniscule in comparison to Spain. People claim that Spain is fine, it's debt-to-GDP is only approximately 68.5%, and it has the backstop of the bailout mechanisms in case of significant future stresses. Well, that isn't the whole story…

Spain recently decided to control the finances of its regional governments, effectively saying that regional deficits were out of control and that the national government is now in charge. Spain also has European-wide liabilities. All of these added, Spain's real debt-to-GDP is much higher than the reported number. With the increased rhetoric surrounding the exit of one or more countries from the currency union, combined with growing anti-austerity political unrest, it looks like there is still more room on the downside.

So, we have a fundamental case to be bearish of the Euro. And with Bernanke sitting on the sidelines not ready to embark on further monetary easing, it looks as though the time for further Euro weakness is here. As the chart above shows, there is a distinct correlation between the level of activity of the Fed and the ECB and the EUR/USD. The orange line is the currency rate and the white is the ratio of the Fed's assets to those of the ECB. As the Fed eases more than the ECB, the currency rate rises, and vice versa. Thus, the ECB has recently eased and yet the cross hasn't followed. The last time this gap was this wide, the euro proceeded to fall about 3000 pips. At a minimum, this pattern is hinting at a target of about 1.20, which is almost 1000 pips below current prices. Thus, it looks like a prime time to short the Euro, either via spot or via the FXE (NYSE: FXE). Any move up towards 1.30 in the 1.2980-1.2990 range is a great place to short in spot, or around 129.25 on the FXE.

Jumping to Asia, the Australian Dollar has been weak recently, as global growth fears rein, especially fears over a hard landing in China. As most know, Australia's export based economy, fueled by its rich deposits of natural resources and is highly dependent on Chinese demand. As China slows, inevitably, so does Australia. Recent Chinese data has hinted at a continued period of cooling in China, which is bearish for the Aussie. Also, softening inflation in Australia recently caused the RBA to cut rates.

After trading as high as 1.08 earlier this year, the AUD/USD has traded down towards parity recently. As the market expects further weakness in global growth, and thus a slowdown in demand for natural resources, it would make sense to be on the short side of this pair. There is support around the 1.01 level, but a break lower through parity would target .97. In the FXA (NYSE: FXA), these levels equate to about 101, 100, and 97 respectively, so a short at 100 targeting 97 seems to be the trade.

Another Asian currency to watch is the one called the “QE indicator,” and that is the USD/JPY. Both central banks, the Fed and the Bank of Japan, have been easing in tremendous quantities, and both have been generally eager to ease further if headwinds to growth prevail. As US growth slows and investors expect more QE, they flock to the Yen and sell the dollar. With the slew of weak US data over the last few weeks, the pair has fallen below 80 for the first time since February. The 100-day moving average sits at 79.73, just slightly below the current level of 79.92. A break lower would target downside support of 79.16. This could be a nice, short-term technical short. It does seem likely that there would also be a bounce off of this level, so a great trade would be to buy the FXY (NYSE: FXY) on a test of the 123.50 level, targeting 120 in the short term.