EUR/USD-Where To Now?

With EUR/USD in unchattered territory the question now is where might it go. I'll tell you what I am looking at but let me mention a few things first. We have all seen news "bullets" regarding "option barriers", "commitments of traders" and information being "priced into the market". While such things are good to know, I remain sceptical of using them for trading purposes for several reasons. First off, barriers and resistance to new levels are always there. I'm sure you can remember when 1.3 on E/U was a major barrier. Every significant step along the way to 1.4 has met with option barriers and resistance.

If you are into sports i'm sure you have heard this phrase regarding sports records: "Records are there to be broken". I like to apply that to support and resistance levels by saying "support and resistance are there to be broken". The trick is to have a good sense of when the "record" is likely to be broken and the likelihood of that happening is when important "new" information comes into the market.

Here are some things we will be looking at:

Sept. 22 (Bloomberg) -- European government bonds fell the most in almost two years this past week after the Federal Reserve's interest-rate cut rekindled speculation global inflation will quicken.

The spread between German two- and 10-year debt yields widened to the most in a month yesterday as traders wagered the Fed's rate cut will encourage consumer spending and push prices higher. European Central Bank officials this week said they're still worried about inflation in the euro region.

"There's a high risk of inflation expectations continuing to rise,'' said Peter Mueller, a fixed-income strategist at Commerzbank AG in Frankfurt. "So the tendency toward lower bond prices and steeper curves should continue.''

The yield on the benchmark 10-year German bund, the security most sensitive to inflation expectations, gained 19 basis points this past week to 4.36 percent by 4:23 p.m. in London yesterday. That's the most since the week of Oct. 28, 2005.

Full Article: http://www.bloomberg.com/apps/news?pid=20601087&sid=aYuFKS3rBZpk&refer=home

Mueller's opinion is not what i'm really interested in. What is of interest is that this article is telling me what to look for as a gauge of whether market participants believe Eurozone inflation will continue or not: 10 y German bond yeilds and the 2y to 10y spread (currently 30 basis points). If the 10 y yeild rises and the spread widens, participants still believe inflation is a threat and that the ECB will raise rates sometime in the future. EUR/USD is likely to keep going up in that case. The info is updated on Bloomberg:

http://www.bloomberg.com/markets/rates/germany.html

The article further states: Royal Bank of Scotland Group Plc economists said they now expect the ECB to cut interest rates next year to 3.5 percent after growth in the region's manufacturing and service industries slowed this month. RBS previously anticipated the central bank would keep its benchmark on hold.

Knowing what RBS thinks is good, however, I believe the deciding factor will be seen in LIBOR. LIBOR is saying that the ECB is still likely to be rasing rates sometime after 3 months. Three month and longer Euro LIBOR has remained elevated while Sterling and Dollar LIBOR's have dropped. You should also know that the fed has never dropped rates only once.

If Euro LIBOR remains elevated or goes higher, 10 y German bond yeild will continue to rise and the 2 y to 10 y spread will widen. EUR/USD will continue to rise if that occurs no matter where resistance or option barriers are. Step one is to get the Monday LIBOR fixing (BB gets it around 7.30 AM NY time-type LIBOR into the search window) and compare that to Friday's fixing.