Sunday 22/01/2012 2PM GMT

The Euro is going down long term but short term we have some strength but long term were going to 1.20 or lower and one of the main drivers of the down trend will be the liquidity injections which the ECB is providing to banks...

The Euro is having a good rally as it's oversold and we have also in an earlier report today looked at, the Net Traders Positions which show an extreme speculative short position held by speculators and this needs to be taken out and the short covering rally is in motion but when its completed, the down trend will resume and new lows will be hit.

We have been short the Euro since 1.42 and when Greece first took its bailout cash we speculated that Euro zone would break up

The Coming Crisis Why Euro Zone Will Break Up

In terms of the long term down trend nothing, still see Euro zone heading for a huge crisis which policy makers seem powerless to stop. We will however probably see a deal done in Greece and the boost of cheap money from the ECB will head off the crisis for now - but while its a short term fix which is good for Euro zone but bad for the currency as printing money means a lower currency and the print is huge.

Short Term a Liquidity Boost

Printing Money = A Lower Euro

So what do we have in place short term? We have a rescue fund and liquidity boost...

Well we have a rescue fund which is far to small to save any of the above countries and we have the ECB giving out money (Quantitative easing in all but name) and as well all know injections of Liquidity cause a currency to weaken and this has been the case in the US and UK and we also know printing money simply creates debt and does nothing really to kick start economic growth.

The ECB recently handed out €489 billion to 523 banks across the 17 countries involved with Italy being the biggest taker this is bigger than either QE1 or QE2 in the US making the ECB's balance sheet the biggest in the world and there will be more liquidity injected.

By providing cheap loans to banks, the logic is some will be invested in sovereign debt and loaned to businesses to kick start the economy but this will not be as effective as people think. Firstly, at present the banks are keeping back most of the money to look matter there balance sheets and it will do nothing to reduce the borrowing costs of nations as its the solvency of nations investors are concerned with. The ECB is gambling that a couple of years down the line, Europe will have seen countries get out of economic difficulties which is a bold assumption and one which we think is wrong.

The Size of the Liquidity Boost

The recent injection of cash was huge and supported over 500 banks with the Italian banking sector getting the major share which was vital at the time. The second instalment of this cheap 3-year money will come on February 29 and the total will be around €1 trillion and to understand how much money this is a simple example I saw graphically illustrates it:

This is equivalent to €4,000 for every man, woman, and child in the zone which is far bigger than the QE in the UK or US.

The ECB is printing money and dropping rates to near zero which is EXACTLY what the USA did. When the US did it, the currency weakened and was used for carry trades and this will happen to the Euro. Fact: Printing money means a weak currency. Its served a purpose short term, by adding liquidity but this solves not of the long term structural problems in the zone.

Structural Problems of Euro Zone

Euro zone is a zone with no central policy, no treasury, and no unity and all the policies we see are reactive rather than pro active. The problem is Euro zone is NOT like USA, and this is the problem.

The countries all have different agendas, the ECB is not the product of one country and a strong central policy is not in place, to deal with problems in a manner which instils confidence in investors. Euro zone simply have no policy in place to stop the ongoing fiscal crisis and the recent summit which drafted the idea of tighter fiscal and economic policy was to little to late and does nothing to help the countries which are in the firing line at present – Italy, Spain and even France which if they fall, are to big to save. Given continued opposition from Germany, a true fiscal union with Euro bonds and a common treasury IS Not an option at present.

Economic growth is contracting in many Euro zone countries and austerity will make this even worse. This is coming at a time when debts are on the increase and the public in many countries is becoming disillusioned with Euro zone policy.

In terms of the Euro, even if we don't see a country tipped over the edge, the outlook is one of misery for many hundreds of millions of people as Europe slips further into recession in the coming year and Euro zone slipping into recession, will affect all major countries in the world and global economic activity will contract which means we remain generally dollar bullish.

Comment

This has been a great trend and we have been following it all the way down from 1.42 and we now and after expecting a rally (which is now occurring now) we expect it to fade. If we get through 1.30, we may have one more push up to 1.32 but overall the trend is bearish and in the next few months we expect to see the Euro at 1.20 or lower.

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