Fundamental Forecast for Euro: Bearish

- The ECB holds rates but takes to the hawkish path by slowly removing stimulus
- Advanced Euro Zone consumer inflation reading turns positive for the first time in seven months
- EURUSD on the verge of a reversal of this year’s trend. Will the dollar take the plunge?

The economic docket for the euro may look somewhat reserved over the coming week; but this should not subdue traders into passivity. In fact, the currency may be spurred to dramatic-levels of volatility should the dollar rally or underlying fundamental themes develop. The pressure on the single currency is most poignantly reflected in EURUSD’s standing. This single pair is the most liquid in the currency market and is therefore the benchmark for trends in not just the euro; but for the entire financial market. Through the end of last week, the pair marked a dramatic correction in the span of only a few hours when it plunged from a range- and trend-high just below 1.5150 to support that defines a nine-month advancing channel. Arguments can be drawn that the actual trend that represents the backbone of this steady ascent has already been broken; but true confirmation will come from a meaningful push below 1.4800. However, a simple technical break on a single pair cannot define a pervasive trend on its own. To see a true changing of the guard with EURUSD, we will need to see a definitive reversal in underlying risk appetite.

In fulfilling its role as the primary counterpart to the US dollar, the euro is naturally imbued with the traits of a high-yield currency (at least when it comes to EURUSD). While the European benchmark lending rate is anemic in its own right and growth forecasts are perhaps more reserved than its US counterpart; diversification away from the greenback naturally channels capital into the next most liquid currency in the FX market. This is a particularly meaningful relationship considering the desire by many of the world’s policy authorities to reduce reserve, domestic monetary policy and economic activity to the health of the whiles of the US dollar. On the other hand, when risk aversion rises; the euro is often the standard bearer for the flight to safety that sends the greenback rallying. We are currently at the cusp of a dramatic shift in underlying sentiment. For much of this year (from Approximately February up until the start of December), sentiment has steadily advanced as investors have put their capital back into the speculative market space. However, the advance that has resulted has moved well beyond the realistic expectations of growth and expected yield growth. Eventually one has to correct to the other; and fundamental economics measure changes in months and quarters. Yet, when positioning for such a significant shift; it is important to confirm that such a seismic change is underway. If a EURUSD break is indeed underway; equities, commodities, fixed income and most other risk-attuned asset classes will all fall into line.

Moving beyond the gravitational pull of the US dollar, the euro is making significant headway on its own. Among the medium-term trends to keep track of for the euro is the slow shift in monetary policy and the pace of the region’s recovery as compared to its peers. The European Central Bank held its benchmark lending rate unchanged at its December 3rd meeting; but the event nonetheless developed a hawkish bias when President Jean-Claude Trichet said unlimited 12 month loans would expire this month and 6-month loans at the end of the first quarter. Officials have said that this should not be considered a sign that the bank is preparing to raise rates; but this is an inevitability given the path the bank is now on. As for growth, there Euro Zone is the collection of member economy’s that are recovering relatively quickly and those that are struggling. The Bundesbank raised its outlook for growth in Germany from stagnant to 1.6 percent in 2010. In contrast, EU ministers are very concerned about the state of Greece’s burgeoning deficits. If the laggards of the region are not supported; it could keep the entire Euro Zone from a robust recovery.

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