Fundamental Outlook for Euro This Week: Bearish

- Euro posts modest gains on ECB rhetoric
- Euro falls on record Euro Zone GDP Contraction
- Our Senior Strategist nonetheless forecasts Euro above 1.3740

The Euro fell against the US Dollar for the first week in four, as a noteworthy reversal in the S&P 500 and other key risk barometers forced gains in the safe-haven US Dollar and Japanese Yen. The Euro now trades at monthly lows against the JPY, and any further deterioration in global equity markets could easily force further losses in the EUR/JPY. A record decline in Euro Zone Gross Domestic Product figures hardly improved financial market sentiment, and the risk of further macroeconomic deterioration looms large for the single currency. European Central Bank rhetoric nonetheless proved supportive; several key members expressed optimism on signs of economic recovery. It may take more than positive ECB commentary to force a sustained recovery in the EUR/USD, however; very short-term momentum points to further Euro losses.

The coming week promises no shortage of Euro/US Dollar volatility, and economic sentiment could take a further turn for the worse on key PMI data. Much has been made of the fact that Euro Zone Purchasing Managers Index reports have shown clear signs of economic recovery. Yet we note that so-called “hard data” in Industrial Production and other timely data releases have not shown commensurate improvement. It will subsequently be important to watch whether the recent pickup in investor sentiment is warranted and sustainable. Consensus forecasts call for a noteworthy jump in the German ZEW business survey’s “Economic Sentiment” index—implying that business conditions are steadily improving. Of course, that data could just as easily reflect the effects of a fairly substantial rally in global equity markets. A worse-than-expected result would likely deflate domestic indices and force a commensurate drop in the EUR/USD.

Later Purchasing Managers Index data likewise remains important, and disappointments in said releases could also herald a turn in financial market sentiment. Recent Euro Zone Industrial Production figures showed record year-over-year drops in domestic activity. Such data stands in stark contrast to improving trends in PMI indices, and one of these pieces of data must shift. Unless we see sustained improvement in PMI figures and commensurate gains in Industrial Production, recent signs of economic recovery will amount to little.

The Euro remains almost exactly unchanged against the US Dollar through the past two months of trade. Previous weeks’ advances may come to an abrupt end if the Euro is unable to break 1.3700 highs against its US counterpart. Indeed, a late-week reversal in the heavily-traded currency pair suggests it may continue to decline into the coming week’s open.

David Rodriguez is a Currency Analyst at FXCM.