Fundamental Forecast for Euro: Bearish

- German unemployment unexpectedly ticks lower, but Chancellor Merkel warns about optimism
- Flash consumer inflation index reports fifth consecutive month the annual reading was negative
- EURUSD has yet to turn a retracement into a trend reversal

There is a reason that EURUSD is the world’s most liquid currency pair. While the European regional and US economies are large trade partners; the real basis for this active is that the US dollar and euro account for the highest and second highest level of reserves in the world’s central banks. The dollar has held the title of top reserve currency (and in turn being used to value commodities, acting as a benchmark or pegged currencies, etc) for decades; but it has been the talk of academic, political and speculative circles for months that the greenback is slowly losing its clout. Who will step in to replace the dollar? Naturally, the euro fits the bill as being the next financial medium for international investors and consumers. Admittedly, such a significant shift will not happen all at once nor is it expected to develop especially soon. However, this relationship is obviously anchoring one currency to the other, leaving the dollar’s strength and weakness to guide the broader trends of the euro.

Its incontestable link with the dollar has in turn stamped the euro with a fundamentally questionable label as a risky currency. For the euro itself, there is little to actually attribute this fundamental title to the currency: there is a modest yield advantage over many of its peers but there is as of yet no clear timetable for rate hikes; and the German and French economies have led the economic recovery for the Western world. However, when most currency transactions are tied to the top safe haven currency, the associative effect is infused. Hence, over the coming week and beyond, euro traders will have to keep a vigilant eye on the underlying currents of sentiment behind the financial markets and the dollar as its proxy. Considering that many of the majors (EURUSD included) have backed up to dollar-based resistance through Friday; the pressure will be on almost immediately after liquidity returns. To confirm that a meaningful shift in risk appetite is indeed underway, a similarly bearish fate for benchmarks among other asset classes would be reason enough to expect momentum. And, while the ultimate collapse or revival in risk appetite will likely be founded through sentiment itself; there are plenty of benchmarks to watch along the way. The myriad of rate decision (the RBA and BoE most prominent among them, but the Fed and ECB certainly important) as well as Friday’s US labor figures offer tangible catalysts to prepare for.

While risk appetite is always important to monitor regardless of what asset you are trading, the euro may still find volatility or alter its position on the risk spectrum through its own event risk. Many of the timely, top tier economic indicators that usually define economic forecasts have already crossed the wires in the past couple of weeks. The primary concern of volatility traders next week is Thursday’s ECB rate decision. The market and economists are unanimous in their forecasts for rates to be held unchanged at 1.00 percent; but there is potential for the statement and President Jean Claude Trichet’s commentary to develop speculation for the timetable for the eventual, hawkish turn. Just this past week, ECB member Axel Weber suggested that it was time to start withdrawing stimulus from the markets. And, just to confirm his bias, he went on to say that policy officials will not wait for employment to pick up to hike rates as by then it may already be too late. In contrast, a draft of the EU’s recent summit reveals officials’ belief that it is too early to start pulling back support for the recovery, though they did not repeat the 2011 timeframe that was suggested before. Euro traders should also be weary of the BoE’s policy announcement (due 45 minutes for the ECB’s) as an expected change to the MPC’s bond purchasing program could spark interest rate speculation throughout the majors.

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