Fundamental Forecast for Euro: Bearish

- A market panic reveals the contagiousness of Euro-area financial troubles
- The ECB holds interest rates, rebuffs speculation that it will begin purchasing bonds
- EURUSD cannot extend a bear trend without at least a temporary correction

After the close of the markets on Friday, European officials ended a summit with another round of promises for regional stability and efforts to defend the euro from speculation. Under normal circumstances, these would be considered strong remarks; and the currency would likely be set up for a strong open next week. However, the problem facing the regional economy is far from normal. After weeks of cat and mouse where officials have tried to reassure without actually paying for its efforts; policy makers have been forced into action as the prospect of a financial crisis has neared the point of inevitability. Having delayed in its response to market participants’ concerns, the EU (in conjunction with the IMF) has seen its obligations inflate from 45 billion to 110 billion euros in loans just to prevent Greece from collapsing. Since the begrudging agreement to these bailouts, it has become quite clear that not even these sums can keep the nation afloat. What’s more, with downgrades to Spain’s and Portugal’s sovereign credit ratings, doubt has been cast over the health of other EU members.

While an objective view of the situation in Europe leaves us with the assessment that conditions cannot be easily fixed, speculative interests are highly sensitive to effort – especially when the currency can be considered temporarily oversold. The past weeks settlement left EURUSD at its lowest holding in 14 months. What’s more, the burst of activity that led the market to its current floor was extraordinarily volatile. Such a setup leaves the euro prone to a quick recovery on even a questionable perk (general risk trends willing). The outcome of this weekend’s meetings could offer just such a boost. After the Friday meeting of leaders from those 16 countries that share the euro, there was an enigmatic promise to both protect the currency and help stall the spread of credit concerns across the region. After a follow meeting with the full regalia of the European Union, specific steps will be announced. But what can they commit to? Those with the check books know that a promise to provide funds will likely be called to task; and an ongoing bailout of the European community is much larger than the collective members can afford. Stretching themselves to a plan to safeguard the entire region would be considered preposterous. On the other hand, a redoubled focus on Greece could prevent one of the certain catalysts to a crisis from igniting (for how long is another question). Alternatively, if the approach taken is considered another wait-and-see effort mixed with a little cheerleading, it will only be a matter of time before market uncertainty naturally spreads and infects other members.

With such an intense focus on the financial stability of European economies, there may seem little need of economic data. However, the foundations of economic activity and interest rate forecasts are essential to both the near and long-term outlook for the currency. Should data deteriorate, confidence in the stability of the financial and monetary union will weaken far more quickly. What’s more, without a robust economic backdrop, a financial panic can turn into a general crisis. This is the pressure that saddles this week’s GDP numbers. With China, the United States and United Kingdom having already released their growth figures; it is now the European group’s turn. Spain has already reported its own recovery from a two-year recession with a meager 0.1 percent expansion through the first three months of the year. Over the coming days, Portugal, Italy, France and Germany are all expected to report growth through the same period. Should there be any wavering in growth before the impact of the recent market fear set in, confidence that stimulus can offer a meaningful boost will all but disappear.

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