Fundamental Forecast for Euro: Neutral

- Euro Zone Unemployment hits 11-year high, Euro falters
- Retail Sales likewise disappoint, raising questions ahead of ECB
- Top event risk will be European Central Bank in the week ahead

The Euro finished the week modestly higher against the US Dollar despite a fairly disappointing string of European economic data. Soft Purchasing Managers Index survey results and disappointing Retail Sales data may have normally been enough to sink the Euro against its US counterpart, but likewise disappointing US Nonfarm Payrolls results left the EURUSD higher. Euro Zone consumers spent 1.2 percent less on retail goods through the month of November—substantively worse than consensus forecasts of no change. The true fireworks may nonetheless wait until the coming week’s key European Central Bank Interest Rate Decision. Relatively aggressive market interest rate forecasts suggest that unexpectedly dovish ECB rhetoric may force substantive Euro pullbacks and it will be critical to monitor any and all commentary from the central bank.

The Euro’s relatively narrow trading range against the US Dollar suggests that markets have reached an impasse. On the one hand, fairly steady improvements in US economic data and a strong surge in US Dollar-long positions suggests that the tides may have turned in the Greenback’s favor. On the other, Euro Zone data has likewise generally improved and the longer-term trend favors continued Euro appreciation against the US currency. A key question in traders’ minds is simple: which major central bank will begin tightening monetary policy the soonest?

Overnight Index Swaps show that interest rate speculators and hedgers predict that the ECB will raise rates by a cumulative 99 basis points in the coming 12 months—noticeably more than expectations of 77bp in Fed rate moves. Relatively lofty expectations may nonetheless be put to the test by the upcoming ECB meeting. Though the bank will almost certainly leave rates unchanged, any suggestions that they may soon raise rates could easily force Euro volatility against the US Dollar and other counterparts. Considerably more dovish rhetoric would likely force the biggest moves, however; comparatively lofty Euro rate expectations leave it at clear risk of pullback on any disappointments.

The Euro Zone economic calendar is otherwise devoid of historically market-moving economic releases, and it will be far more important to watch market positioning and sentiment through various measures. As we wrote recently, CFTC Commitment of Traders data shows that large speculators remain the most net-short EUR/USD since it bottomed in late 2008. Whether or not history repeats itself may be a question of key fundamental developments out of the world’s largest economies.

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