Fundamental Forecast for Euro: Neutral

- Euro technically fails at former support line
- European Producer Prices fall most on record
- Euro sold following European Central Bank rate decision
- View our monthly Euro US Dollar Exchange Rate Forecast

The Euro largely ignored a week of substantial economic event risk and remained nearly unchanged against the US Dollar. Early-week declines in the US S&P 500 and broader risk sentiment initially pushed the European currency lower against its safe-haven US counterpart. Yet traders showed little desire to break key asset classes from important ranges, and the S&P recovered much of its earlier declines. The clear exception came on a sharp rally in Gold prices, which finished just short of fresh year-to-date highs. Impressive strength in the precious metal suggests investors are once again seeking stores of value, and such ostensibly risk-averse behavior bodes poorly for global equity markets and key risk-linked currencies. Indeed, the gold rally comes despite relative US dollar stability and underlines the recent shift in market sentiment. Short-term forecasts for the Euro itself are comparatively unclear, but the EURUSD’s failure to challenge recent highs leaves near-term risks to the downside.

Exactly a week ago we argued that the “September effect” in equity markets made Euro declines likely versus the safe haven US Dollar. As if on cue, the first of September saw equities and the Euro fall sharply to start off the month of trading. Equities have since partially recovered, but indices such as the S&P 500 remain well off their very recent 2009 highs. We continue to argue that an equity market correction is likely; if nothing else, their seasonal tendency to decline in September leaves previously impressive rallies at risk of pullback.

Yet volatility has been difficult to come by across financial markets, and expected price moves—as seen through FX options markets—remain near their lowest levels since the Lehman Brothers collapse in 2008. The month of August typically sees the lowest forex and equity market trading volume of the year—leading to sharp but choppy price moves. The natural increase in trading volume through September leaves hope that market conditions could eventually return to “normal”, but the past week feels like a continuation of previously directionless FX price action. The timing of the return to strong directional price moves remains elusive, and a drop in economic event risk leaves little scope for major Euro/US Dollar breakouts.

The European economic calendar is light in the week ahead, with a number of German fundamental data releases unlikely to force major moves across Euro pairs. Wednesday’s Consumer Price Index report is expected to show that prices remained flat on the year, and only a sharply surprising result is likely to force re-evaluation of European Central Bank rate forecasts. Otherwise, traders will keep an eye out for noteworthy changes in domestic Industrial Production and Trade Balance numbers.

The key question is whether we can expect markets to break their choppy ranges as trading volume increases through September. We have thus far seen little scope for sustained Euro/US Dollar moves, and indeed range traders seem in pole position to rack up further gains in the week ahead.

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