Fundamental Forecast for Euro: Bullish

- Greece debt rating cut to Junk, Portugal following the same path
- Spain rating downgrade suggests financial trouble spreading to larger EU economies
- EURUSD rebounds from 12-month lows, which trend will develop into next week?

Is the euro on track for a fundamental upswing? It may seem absurd to suggest a currency that is facing an internal financial crisis and has summarily been relegated to the lower echelons of growth and interest rate expectations is preparing to mount a charge. However, fundamentals go only so far in explaining the direction and progress of a currency. The true determinant for the euro or any other unit’s strength is speculative sentiment. So, while the medium-term health of the European region has been severely diminished over the past weeks with downgrades, a weak commitment to ensuring stability and a dramatic rise in debt financing costs; there may be a sense of optimism to be found in the fact that conditions have not deteriorated further. Given the default premiums that have been priced into the currency and its assets recently, a steady stream of disappointment and fear is needed to bear these extreme levels of uncertainty. Otherwise, the extraordinary costs of insurance will be deemed too high. Furthermore, a balancing of sentiment could further tip into a short-term rally should the European Union finally accept the conditions of the financial assistance package promised to Greece some weeks ago.

Approximately three weeks ago, the EU and IMF looked to quell doubts over Greece’s solvency by announcing a 45 billion euro financial assistance package that would be made available to the member should it be activated. Though it may seem impractical at this point, there was no doubt more than one official that had hoped that the mere promise of support eliminate fears. However, just a week later, the Greek Prime Minister Papandreou would be forced to activate the life line. And, even though the nation finally changed its tune from assuring the market’s that it could handle its fiscal obligations without help, the EU would not be so quick to open the purse. Debate has continued over the conditions of the loans that will be made; though officials have promised discussions were on the fast track. Yet, since the official plea for help, Greece’s situation has worsened with a sovereign credit rating downgrade to junk and cuts to both Portugal and Spain. The IMF has estimated that it may take a total of 100 to 120 billion euros to stabilize Greece. The total to support Portugal, Spain, Ireland and Italy among others could run much higher. Will funds be made available for everyone? No. But, whether or not this turns into a crisis depends on the general health of the speculative markets. For the short-sighted traders, the release of the 45 billion euro aid package would likely be considered a bullish outcome – at the very least, it defers the immediacy of a collapse. And, though the future may look bleak, it is important to always look at it through the perspective of the investor and creditor.

Though the EU/IMF bailout effort holds the most potential over the market, there are more distinct threats to volatility through the week. At the top of list is Thursday’s ECB rate decision. It is difficult to imagine this event will be very market moving considering the UK election will be a distraction and policy officials won’t change their tune on interest rates until inflation perks up and financial stability firms. On the other hand, interest rate speculation is a sensitive subject. Should there be a suggestion of time frame in the commentary (near or distant) it could encourage the markets. Other indicators (i.e. regional PMI numbers, German industrial production, Euro Zone retail sales) pose only a modest threat to volatility.

DailyFX provides forex news on the economic reports and political events that influence the forex market.