On October 20th 2009 Bloomberg reported a news snippet saying that “ European finance officials are concerned the Euro’s climb to a 14-month high against the dollar is eroding exports”.

The same day French President Nicolas Sarkozy called the move a “disaster” for the economy.

Since February Euro has gained almost 20 percent against the dollar making the Euro zone’s exports more expensive to overseas buyers and threatening the economic recovery from the worst recession since World War II.

Sarkozy’s counselor, Henri Guaino, said that the U.S. is “flooding the world” with dollars and that the currency’s weakness may become “unbearable.” An exchange rate of $1.50 per euro “is a disaster for the European economy and manufacturing sector.

Treasury Secretary Timothy Geithner said on Oct. 3 that it is “very important” for the U.S. to have a strong dollar the reason being US is primarily an importing country and a further weakening of dollar could lead to significantly high levels of current account deficits

In view of this, I strongly believe that the European Central Bank would take every possible step to ensure that its currency does not appreciate further.

Couple of weeks back when Euro was near 1.5, Nifty index was around 5200 and other major global indices was also at their peak.  Then what happened was the Nifty corrected to 4500 levels and other global indices also had the same fate. This however was accompanied by Euro reaching almost 1.47 levels unnoticed.

The relation is that, if Euro weakens form here, that means dollar will gain strength and with dollar gaining strength comes the correction in all major base metals and crude. Moreover, in almost all the top world indices, whether Dow Jones or Nikkei or Nikkei, the weight of commodity driven stocks is the maximum. Thus a correction in global commodities because of a weakening euro will inevitably lead to a correction in the global equity markets.

Again since a correction did take place some time back, there is a strong possibility that it shall repeat itself, given the fact that Euro is nearing 1.5.

Hence, I believe the trading strategy one could adopt currently is to go short on the Nifty Index, base metals, crude and commodity driven stocks like Crain India, Reliance Industries, Hindalco, Tata Steel, Sesa Goa, Sterlite, etc. The stop loss one should keep is a Euro level of above 1.51.

Author: Rahul Sonthalia, Analyst, Kredent Group

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