Fundamental Forecast for Euro: Bearish

- German investor sentiment unexpectedly falls for the first time in nine months
- Regional consumer prices contract for the first time since 1996
- ECB Member Bonello says bank ‘satisfied’ with current level of rates and quantitative easing

Compared to some of its liquid counterparts, the euro saw relatively staid price action this past week. Fundamental traders can thank the market’s interest in earnings and burgeoning financial troubles which kept traders’ focus on those currencies with more blatant connections to risk appetite. However, the euro is certainly not immune to these underlying drivers; and we will likely see the euro crowd react to these influences more readily going forward. What’s more, with growth numbers starting to cross the wires and significant round of economic data scheduled for release in the second half of the week; there looks to be enough fuel for EURUSD to force a breakout from its 1.4200-1.3800 range relatively soon. The question we need to ask while evaluating the fundamental landscape is whether the break will be a bullish or bearish one.

While there is a significant round of event risk to work with over the coming week; the most likely catalyst for price action for the euro (or any currency for that matter) is risk appetite. Earnings have had a distinct and severe impact on both the US dollar and Japanese yen; but the significance of such trends for the euro seems to have been overlooked. This is not likely to be the case for long. The European earnings season picks up next week; and the corporate sector’s health will be a robust and current gauge of market and economic strength – a dynamic that will be vital to speculators who have to wait until mid-August before the government reports its first readings of 2Q GDP (well after the UK and US). Another potential catalyst for risk resides in the financial markets. Here too, earnings will play their part. In its most recent Financial Stability Review, the ECB forecasted regional banks would write down another $218 billion in bad debt through 2010; but the IMF sees the figure much higher at $750 billion. If growth doesn’t take hold and buffer these losses (as policy officials are likely hoping for), this losses could trigger a delayed, European crisis. Turning from company to country risk, the health of many Eastern European countries and their banking systems are still a point of contention. As the larger Euro Zone members take a more frugal policy stance, neighbor bailouts could suffer during a time of particular vulnerability.

From the EURUSD response to the swell in risk appetite over the past week, the influence of each fundamental driver can have a different intensity for different currencies. Aside from risk, the other essential theme in Forex going forward is growth. As market commentators and participants latch on to the very early signs of an economic recovery (which is more a deceleration in the pace of recession at this point), the sensitivity to forecasting which nation is pacing the revival will increase. This is especially true for the Euro Zone which has collective spurned international calls to inject further stimulus funds into its economy to prevent further troubles down the road. This is a gamble which could amplify a double dip recession or pay off by accelerating the return to growth while allowing the government to work down its deficits more quickly. The IMF has projected a comparatively weak rebound for the regional economy with a 4.8 percent contraction this year and 0.3 percent expansion in 2010. This past week, China reported the first increase in the pace of economic activity since the beginning of 2007. Next Friday, the UK will mark the first developed country to report – and the trade ties and proximity of these nations will not go unnoticed by euro traders. However, there will be plenty of fodder for those that want direct fundamental contact. Euro Zone industrial production and current account numbers gauge growth through factory activity and trade. Though, it will be the advanced PMI figures for July that really offers speculators something to work with.

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