Fundamental Outlook for Euro This Week: Bearish

- Euro gains slow on weak retail sales data
- Improved investor sentiment nonetheless improves euro outlook
- Euro nears a technical breakout

The euro finished at multi-week highs against the US Dollar, as a week-long rally in the S&P 500 hurt the safe-haven US currency. The short-term correlation between the EUR/USD and the S&P remains near record-highs, and recent trends imply that further stock market gains would lead to Euro strength. Wave after wave of bearish European economic data nonetheless limits optimism for the heavily-traded EMU currency. Fresh economic distress highlights structural risks to the Euro Zone, and FX markets will keep a close eye on developments through the weekend’s G20 summit.

Traders await the conclusions from contentious meetings likely to take place among global economic leaders. US officials have clearly stated their desire for an aggressive global response to the economic and financial crises, but their European counterparts have shown clear resistance to matching sizeable US fiscal and monetary stimuli. Fears of snowballing fiscal deficits and the terms of EU membership prohibit many members from aggressive public spending, and this may in fact leave the Euro Zone at a disadvantage. Furthermore, the European Central Bank seemingly lacks the power to enact similarly aggressive monetary policy. These two key limitations suggest that the US may enjoy more favorable conditions for eventual economic recovery. The risks of EMU and ECB inaction on domestic financial and economic crises continue to mount, and the euro could potentially suffer against the US dollar through the medium term as a result.

Through the shorter-term, traders will keep a close eye out for the coming week’s key European inflation and investor confidence results. Analysts predict that Euro Zone Consumer Price Index inflation picked up through the month of February. Such results could further handicap the European Central Bank’s ability to boost domestic economic prospects. Unless we see real risks of deflation, the ECB is unlikely to drop interest rates far beyond current levels. Otherwise, surprises in upcoming German ZEW figures could elicit responses in financial markets and—by extension—the euro itself. Given that the EUR/USD continues to trade almost tick-for-tick with global stock indices, it will be critical to watch whether the S&P 500’s recent recovery leads to further short-term gains.

David Rodriguez is a Currency Analyst at FXCM.