Fundamental Outlook for Euro This Week: Bearish

- German business confidence drops to a 26 year low – support for a recovery waning
- European manufacturing and service sector activity rebounds slightly…but from record lows
- Euro’s late-week decline suggests dominant downtrend may have been revived

It was a late break for the euro this past Friday; and a meaning full one at that. Against its US counterpart, the European currency finished more than a week of congestion near multi-month highs with a plunge that called into question the underlying health of the euro. This uncertainty is warranted considering the development in fundamentals behind the scenes over the past weeks and months. Whereas the euro was once treated like a currency that could weather the worst of the economic storm, retain its relatively high yield and show the solidarity of its union structure; we now see that the Euro Zone is in just as bad a shape as its global counterparts. There is a wide range of data, rate decision and the G20 meeting all penciled in this week; and there is little room for the euro to find significant benefit from any of these events.

A global affair, the market will likely forgo its immediate concern for any other market drivers until the Group of 20 summit is concluded and the full extent of their plans are announced on Thursday. Ultimately, the aim is that all economies would benefit from a global effort to turn the world-wide recession around and stabilize the financial crisis; but some will benefit more than others. So far, European leaders have committed less to their regional economy than the US, UK or China. This has been a point of contention for the IMF, US President Barack Obama and UK Prime Minister Gordon Brown who have all called on the Euro Zone to commit more of their budget to financial stimulus; and all have been rebuffed. Everything else being equal, if the global economy started to turn around today, the Europe would be in a great position with relatively less money tied up in deficits and less of their financial system in the hands of the government. However, if leaders do cave to these pressures, then the potential for a quick rebound will be lost.

Another euro advantage that has been slowly deflated is the steady decline in the benchmark lending rate. Before the European Central Bank began to hit its stride with aggressive rate cuts, President Trichet’s promise to target inflation led many to believe that the euro would maintain a positive yield spread over its US and UK counterparts through the life of the current recession. This was another potential catalyzing benefit of the economy that could leverage a rebound in the euro should risk appetite recover. However, the main rate has since tumbled. Currently at 1.50 percent, the policy group is expected to cut another 50 basis points off their target – bringing them within the pull of the near-zero level that has captured so many others. Trichet and some other policy members seem acutely aware that there is no real benefit to cutting rates beyond a certainly level; but the group seems to have already sounded the warning.

With the G20 meeting and ECB rate decision both due on Thursday, that leave a lot of the week open to other fundamental swells. Of course, in the lead up to the aforementioned event risk, the response to more mundane event risk will likely settle. When removed from these two releases are removed from the equation though, we can see a significant amount of data that can help define the next leg of Europe’s recession. Euro zone sentiment readings (consumer, business, economic), final readings on sector activity gauges, employment, inflation and retail spending will provide a clear bearing for 1Q GDP.

John Kicklighter a Currency Strategist at FXCM.