Fundamental Outlook for Euro: Bearish

-- IMF forecasts more European banks could fail as recovery is not expected until late 2009
-- FXCM SSI shows that EUR/USD positioning flipped to net short last week – reversal potential?
-- Euro-zone services, manufacturing PMI holds below 50, signaling contraction, for fifth straight month

After falling nearly 6 percent last week and testing critical support at 1.2500, many are hoping that EUR/USD will finally turn higher soon. However, Euro-zone economic releases will be working against that as nearly every report is forecasted to deteriorate. First, Germany investor and consumer sentiment as measured by IFO and GfK, respectively, is anticipated to slip in light of the worsening credit market conditions, indications of recession in the region, and mounting job losses. Likewise, retail sales are expected to fall negative as domestic demand wanes. However, the release of Eurostat’s estimate of Euro-zone CPI may have a bit more market-moving potential, as the index is likely to show that inflation growth eased to a 3.2 percent pace in October from 3.6 percent. Given European Central Bank President Jean-Claude Trichet’s more bearish stance on economic growth and the bank’s participation in the October 8 coordinated rate cuts, a weaker-than-expected CPI reading could exacerbate the market’s speculation that the central bank will cut rates again soon. We also have to consider that the Euro-zone unemployment rate will also be released at the same time and is forecasted to hold steady at 7.5 percent. Given the dismal conditions plaguing the region’s economies, there is a risk that the unemployment rate will tick higher, and combined with a drop in CPI, the euro could easily plunge.

However, the forex markets have brushed off most economic releases over the past few weeks as risk appetite has become the primary driver of price action. As a result, if we see that investor sentiment improves a bit and risky assets like oil start to gain, especially in light of OPEC’s 1.5 million barrel per day output cut last week, EUR/USD could finally recover, or at the very least, hold above near-term support at 1.2500.

Antonio Sousa is a Currency Analyst for FXCM.