Euro Fundamental Outlook: Bearish

Forecasts for the euro/US Dollar Exchange rate took a turn for the worse, as a steady stream of bearish economic data dimmed outlook for the broader Euro Zone economy. The EUR/USD finished marginally higher through the week’s close despite a deterioration in economic outlook, but this was largely a function of broader US dollar weakness. When we look at fresh fundamental developments out of the EMU, we see that German IFO consumer confidence fell yet again, and Ireland became the first EMU economy to officially enter two consecutive quarters of negative GDP growth. Though the former “Celtic Tiger” is not necessarily comparable to other major European Monetary Union states, many believe that it will only be the first of several countries in the EMU to enter technical recessions. Such pressures may leave the European Central Bank with little choice but to ease interest rates in a bid to boost flagging European growth rates.

- European growth concerns emerge, force pullback in the EUR/USD
- Euro/US dollar may run out of gas on weakening fundamentals
- Is the Euro-Zone headed for a recession?

The coming week will go a long way in clarifying outlook for European interest rates and the euro, with a European Central Bank interest rate decision to drive market volatility through late week trade. Analysts widely forecast that the ECB will leave rates unchanged in their Thursday morning announcement, but Overnight Index Swaps are actually pricing in an approximate 20 percent chance that the ECB will cut rates by 25 basis points. Market indecision ahead of the event will likely make for volatility regardless of the outcome, and it will be very important to listen to any shifts in rhetoric from ECB Governor Jean Claude Trichet.

Trichet is known for being quite candid with the ECB Governing Council’s stance on interest rates, and we cannot rule out the possibility that he will signal rate cuts through upcoming meetings. A recent drop in German Consumer Prices arguably gives the ECB breathing room as far as inflation is concerned, and dimming domestic growth prospects will only increase political pressure on the ECB to cut borrowing costs. A dovish turn in ECB rhetoric would likely cause a noteworthy selloff in the EUR/USD.

Otherwise, euro traders will need to watch developments out of the US economy. Market indecision surrounding the US Treasury’s plan to bail out credit markets will continue to drive sharp price moves in the USD, while the infamous US Non-Farm Payrolls report will likewise force major dollar volatility through end-of-week trade.

Jamie Saettele is a Technical Currency Analyst for FXCM.