Fundamental Forecast for Euro: Bearish

- European Central Bank’s Trichet talks down Greece concerns
- Technicals show mixed forecast for Euro, but risks to downside

The Euro finished the week lower against the US Dollar and other key counterparts, hounded by ongoing turmoil in Greek debt markets and the tangible risk that Greece would require financial bailouts from the International Monetary Fund and fellow European Monetary Union members. That Fitch ratings downgraded Greece’s sovereign debt by two notches only exacerbated fears of possible default, and yields on Greek bond soared to incredible heights on very limited investor demand. Indeed, even short-term Greek bills yielded a previously-unthinkable 7-plus percentage points at their peak. The spread between 10-year Greek Government Bond yields and benchmark German Bunds likewise hit record-highs—fueled by a flight to the relative safety of German sovereign debt. Rumors that a €20-25 Billion EMU/IMF bailout was imminent proved unsubstantiated, and the legitimate threat of further Greek fiscal turmoil hangs over the Euro ahead of several key economic releases.

Whether or not the IMF and/or the EMU offer Greece explicit financial aid may be a critical deciding factor in near-term EUR/USD moves—promising a great deal of volatility as rumors swirl and officials offer their opinions on the matter. Event risk on the calendar could likewise provide some short-term price spikes ahead of Euro Zone Industrial Production and Consumer Price Index data. Fairly disappointing industrial activity numbers leave expectations riding low ahead of Wednesday’s release, while similarly lackluster Consumer Price Index data has left forecasts low ahead of German and broader EZ releases. We do not expect any especially large moves absent a material surprise in any of these data releases, but it is important to keep event risk on the radar and sometimes expect the unexpected.

Our focus will otherwise remain solely on fiscal debt developments and a planned auction for Greek debt on Tuesday. Officials seek to raise a total of €1.6 billion via sales of 26 and 52-week Treasury Bills through the upcoming debt auction. In most circumstances, such short-dated debt should come cheaply as investors do not demand significant default risk premiums on fast-maturing debt. Yet a cursory look at the yield curve for Greek debt shows that almost all bonds—whether maturing in 26 weeks or 10 years—yields as much as 600 basis points above their benchmark German equivalent. Such incredible spreads bode poorly for the upcoming auction; further bond supply will likely only exacerbate market fears and could legitimately prove a boiling point for the ongoing fiscal crisis.

Fiscal concerns remain the greatest risk to Euro Zone unity and arguably the Euro itself. Many believe that an IMF-led bailout is looking increasingly inevitable for Greece, and the uncertainty surrounding specific details of said bailout places strong downward pressure on the single currency. We subsequently wonder whether any concrete announcements would cause sharp Euro recovery. Such an outcome is of course entirely possible, but we remain skeptical that financial assistance will be the cure-all for the Euro Zone’s fiscal ills. It suffices to say that anything is possible, and traders should remain very much alert on the possibility of sharp volatility on any and all developments.

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