Fundamental Outlook for Euro: Bullish

- Liquidity crisis overwhelms all other fundamentals this past week
- ECB joins global effort to stabilize financial crisis with a massive liquidity injection
- German ZEW investor confidence gauge rises in September read measure cutoff misses crisis

As it was with the rest of the currency market, the evolving financial crisis from this past week elicited incredible volatility from the world’s most liquid currency pair. Indeed, the pair established a massive, 450-point range (the limits of which were tested many times over) that has left the market with notable technical levels to test in the days ahead. However, with the worst of the financial crisis seemingly past, the market will likely swap volatility for direction going forward. On the other hand, this once in a generation market event won’t leave the euro unscathed. Risk appetite will be treated like a raw nerve next week; and though there may be a rebound in demand for the market’s higher yielding assets, there will certainly remain a sense of caution behind the buying. With a market that puts a premium on liquidity and financial stability (just in case conditions sour once again), the European currency will be a natural alternative to a weakened dollar as the second most liquid currency in FX and with a diversified market structure.

Another side effect of the market turmoil will be how it has effected the long-term fundamental outlook. Certainly, all economies will have suffered from this crisis; but in the Forex market, strength and weakness are relative. This is the reason for the bullish outlook (even though most of the scheduled data is painted in red). In the wake of last week’s insanity, we can see that there is still a significant forecast for a Fed rate cut (though the dovish outlook has improved markedly from yesterday). What’s more, if there was any doubt that the US economy would be able to avoid a recession going forward, the impact this period will have on US employment, consumer spending, business investment and the housing market going forward leaves little doubt of that now. In comparison, President Trichet’s hasn’t even wavered on his vow to fight inflation through monetary policy though he had joined in on the liquidity wash. What’s more, the slowdown in the Euro Zone is already well known and the euro has already adjusted to reflect the cooling. On the other hand, on the back of the dollar’s unabashed rally, it seems fundamental traders are relying on the strong numbers from 2Q US GDP to carry forward.

Taking measure of the hurdles in scheduled event risk, there are a number of indicators that will do well to take measure of the economy and sentiment after the financial meltdown. For growth, the PMI service and manufacturing figures for September will bring us back to the underlying economics in the economy. Likely to be far less equitable for fundamentals, we will also see the readings of consumer and business confidence for Germany. We will need to take these numbers with a big grain of salt as they can vary severely depending on when the assessment period ends – though price action may be far more volatile in its response as the important thing here is how objective the market is towards the data.

John Kicklighter a Currency Strategist at FXCM.