Fundamental Forecast for Euro: Bearish

- Timely manufacturing and service sector data undermines growth outlook
- Ireland’s long-term sovereign rating is cut and yet yields still fall at its next debt auction
- EURUSD attempts to retrace some of its losses; but is this a reversal or mere correction?

The euro had an uneven performance this past week; but the outcome that really mattered for the shared currency was the progress made against the US dollar – its primary counterpart. In fact, EURUSD climbed through the last three days of the week as the risk aversion drive steadied and the greenback saw its appeal as a safe haven diminish. This is not to say, however, that the currency market’s most liquid pair has put in for a definitive reversal. Though the pair did advance, it covered relatively little ground. When we extract the dollar from this equation (which is difficult to do given its influence over global sentiment, activity and liquidity), what are we left with? Europe’s troubles remain and scheduled event risk is actually set to pick up over the coming week. Stability to this point is merely a natural consequence of the market’s preoccupation with other exogenous factors. These distractions may not last going forward; and they may actually weigh the euro going forward.

As any experienced fundamental trader should realize at this point, the greatest fundamental threat to volatility and trend going forward is underlying investor sentiment. Risk appetite is an essential support for the Eurozone going forward. To ascertain the influence this general state can have on the region going forward, we should consider the financial trouble the economy faces. Despite policy officials’ claims that the region is booming, few would argue that the Euro area faced a crisis back in May when fear over a Greek default hit a frenzied state. While financial conditions may have stabilized since the EU / IMF joint bailout effort; the reality of the situation is that the markets are surviving on the good will of the global investors. A lack of panic has prevented a severe increase in sovereign and corporate lending rates and kept liquidity flowing. And yet, conditions are still distressed. All that is needed is a revival of fear somewhere in the global economy; and Europe will quickly come back into focus for the precarious situation it faces with balancing a downturn in economic activity with austerity efforts.

Looking for specific fundamental catalysts for underling risk appetite, there are a number of top tier indicators that could be stir the global pot. On the other hand, similar indicators were hailed for their capacity for reviving volatility only to pass without significant impact. More likely than not, the ultimate catalyst for market-wide risk appetite or risk aversion likely falls to exogenous drivers. That being said, it is worth monitoring the updates that refer to government’s success in raising capital (Portugal and Spain are set to sell bonds); banks need for liquidity from the ECB; and the tensions in supporting a nascent recovery versus cutting deficits to meet EU standards.

Big themes will likely determine any trades that develop; but there is a high probability that a number of key indicators could generate volatility and short-term swings. Top event risk is Thursday’s ECB rate decision. No changes to the benchmark rate are expected; but the market will benchmark Central Bank Trichet’s policy tactics from here against his US counterpart. A reference to the bond purchasing effort is what traders want to hear. After the ECB, the German unemployment change, Eurozone consumer inflation estimate, unemployment rate, 2Q GDP revision and array of confidence indicators all have influence.

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