Fundamental Outlook for Euro: Bearish

- The ECB hold rates and Trichet keeps his sights set on fighting inflation
- Central bank’s inflation concerns substantiated as upstream pressures still pushing records
- Euro Zone not immune to global slowdown in growth and interest rate expectations reflect that

Has the euro already reached the point of no return? This is the question traders will have to ask next week when liquidity returns to the currency market. There is certain to be a growing call among the speculative base for a necessary rebound from the battered currency since it has plunged nearly 1850 points or 11.5 percent against its US counterpart since hitting record highs less than two months ago. However, despite the new week, the fundamental argument for EUR/USD will be the same: which currency is attached to the better interest rate and economic forecasts (a similar measurement being used across the FX market).

Recently, the US dollar has been looking less sickly. For comparison, second quarter numbers showed the US economy marked a sharp rebound to expansion while the Euro Zone saw its first quarterly contraction since the euro was introduced. From an interest rate perspective, forecasts for the Fed were steady with two quarter-percent hikes due by the same month a year for now; while the ECB – despite the constant harping on inflation was expected cut by just as much. This may change in the days and weeks ahead though. While the outlook for the European policy authority continues to fade (as it should), the optimistic FOMC forecast is also starting to fail. With commodity prices easing and global growth cooling, Fed Fund futures have started to price in an 11 percent chance of a cut by December. What’s more, on the growth front, the US revival isn’t likely to hold through the second half of this year. So, while European expansion may continue to decelerate, it is the outlook for the US that can falter the most. It’s always a relative trade for the currency market.

Elsewhere in fundamentals, the scheduled docket may generate some buzz for the euro. Thursday’s reports will have the greatest impact on the economic outlook. The ECB’s September report will likely reflect the ruminations from Trichet in his prepared statement and public address last Thursday. The European Commission’s growth forecast on the other hand could come with surprises, though the ECB’s downgrading the 2008 outlook from 1.5-2.1 percent to 1.1-1.3 percent and 2009 forecast from 1.8.-3.0 percent to 2.3-2.9 percent could certainly use some clarification (because they look somewhat optimistic at this point). The only other indicators that have a chance to move markets will be the quarterly employment report and the German trade figure.

David Rodriguez is a Currency Analyst at FXCM.