Fundamental Outlook for Euro This Week: Bearish

- European banks come under stress, threatening the entire Euro Zone economy
- Will the Euro Zone make a coordinated effort to right the economy?
- The Euro Zone’s growth outlook is fading fast as PMI readings push record lows for 1Q

This past week was a dramatically volatile one for the euro with a major break below 1.2700 and an eventual reversal that left EURUSD essentially unchanged at the end of the week. Now, with momentum dragging the world’s most liquid currency pair towards a bearish breakout that could redefine trend, it seems the market will be forced into a decision about the general strength of the euro and its fundamental place against its US counterpart. In deciphering the larger drivers for the euro, there are a few potential engines that have enough pull to alter the course to one of the world’s most actively traded assets. The greatest potential for impact will come from the US dollar as the market tries to define its role as a safe haven and the part it will play in leading the global economy out of the gloom of the global recession. In contrast, the unspoken, positive light that the Euro Zone and its currency have been long cast in will come under pressure. With the financial crisis having a heavy impact on the region recently and a heavy flow of data, fundamental traders will certainly have a lot to work with this week.

The membership model of the Euro Zone was long hailed as the next progression of global economics. Inevitable were correlations to the United States and how it operates at the national level and as individual states. However, the European Union is much more complicated than that; and it’s cracks have started to turn into crevasses recently. Just this past week, the market was put into a panic when it was suggested that the rating agencies were contemplating a downgrade of bank debt in Eastern European economies that have seen especially sharp contractions in growth. In contrast to the Greece, Spain and Italy sovereign downgrade, this news was not as specific to the Union. However, it was a sign that the smaller economies could fall into the same economic crisis that Iceland had suffered just a few months back. With trade and capital lines through these economies, it wouldn’t take long for a collapse of an economy on the edges of the Euro Zone to spread to its bigger members. To help fortify confidence, the banks with branches in those economies buffered the local banks’ reserves were buffered with $2 billion and the German Finance Minister suggested they were ready to bailout member economies should they require. However, with so many individual economies and little in the way of a coordinated effort from the European officials to this point, skepticism will remain.

While risk and financial stability will be the main drivers of for a market that is always deriving relative value; there is still general growth and interest rates still to consider for the euro. Interest rates are still key to the euro’s strength going forward as the ECB’s decision to leave the benchmark lending rate untouched last month kept the primary yield at a relatively high 2.00 percent. This confers a clear benefit through interest rate differentials as speculators will eventually look beyond this economic slump to expectations for an eventual recovery that will leave investors looking for the highest level of demand. Growth will similarly define yields for local assets. With the ECB’s next rate decision a couple weeks away, we will have to monitor growth and inflation data on hand. The German and Euro Zone CPI data will reveal how easily the ECB will be able to consider rate cuts. More important though are those readings that factor into growth and financial health. Should employment, business activity, industrial output and consumer confidence fade; it could encourage the central bank to do more to fortify their economy through policy,