Fundamental Outlook for Euro: Bullish

- Are “second-round effects” plaguing the Euro-zone? ECB’s Stark says yes, EU says no.
- Overnight index swaps may be pricing in rate cuts, but ECB members sure don’t sound like they’re planning on it.
- Which commodity does EUR/USD have a strong link with? Find out in our latest forex correlations report.

After a wild week of Euro price action that included a 500+ pip decline to one-year lows near 1.3900, and a subsequent 300+ pip rally on Friday, shell-shocked traders may not know what to do next. Indeed, the oversold currency finally reversed following weeks of declines, and ooking at recent FXCM SSI readings, EUR/USD positioning flipped from net long to net short on Friday. As a contrarian indicator, this suggests the pair could gain further over the course of the next week.

However, there is still quite a bit of rate cut speculation, as Credit Suisse overnight index swaps are now pricing in nearly 50bps in reductions by the ECB over the next 12 months, compared to 25bps in cuts just two weeks ago. Thus, from an interest rate perspective there’s still downside risk for the euro, and there is notable resistance looming above at the 38.2% fib of 1.4812 – 1.3880 at 1.4236.

Taking those factors into account, EUR/USD may start the week off on a softer note and as usual, the pair may depend more upon US dollar sentiment for direction. Nevertheless, there will be hefty event risk on hand this week with Euro-zone CPI anticipated to hold well above the ECB’s 2 percent target at 3.8 percent in August, the German ZEW survey is expected to edge higher, the trade deficit is forecasted to widen, and producer prices may slip on the August drop in commodities. The key to trading will be Euro-zone CPI, and if the figures prove to be stronger-than-expected, the markets could start to cut back speculation that the ECB will cut rates over the next 12 months.

Terri Belkas is a Currency Strategist at FXCM.