Fundamental Forecast for Euro: Bearish

- Ireland to split Anglo Irish Bank in an effort to defuse a financial bomb
- Norway Sovereign Wealth Fund invests in shunned Greek and other trouble EU countries’ debt
- Greek consumers and businesses withdraw 4.2 billion euros from national bank accounts

It would be a stretch to simply imply that the euro experienced elevated volatility this past week. Considering European traders were returning from their summer holidays and US-based speculators rushed back after an extended holiday weekend, there was wave of risk-sensitive capital that washed over the market and offered the best opportunity for a meaningful breakout that we have seen in a month. And yet, EURUSD would hold its sideway track. Now we turn to the coming week and attempt to gauge the potential of that long-awaited breakout that will provide finally establish a meaningful direction for the capital markets and shared currency. Considering the euro’s bearing is heavily dependent on its performance against the US dollar and risk appetite in general, the fundamental trends to encourage this market along are perhaps larger than the currency itself. That being said, global investor sentiment itself could actually establish its bearings on European financial and economic developments.

It should come as no surprise that policy officials are singing the praises of their respective economists and financial markets. It is their job to be cheerleaders and encourage confidence as much as possible. However, these assurances ring hollow when we consider the growing troubles of the region. At the forefront of our concerns for Europe are the cracks in the effort to balance economic growth and fiscal prudence. From Ireland, the deputy director of the country’s debt office said the nation was fully funded until June of 2011; but does this assessment account for the burden that the Anglo Irish bank could place on the coffers? The plan to split the troubled back (which has already required 22.9 billion in bailout capital) is a design that has failed in other instances and will not magically erase the costs of nationalization. For Greece, the IMF’s approval of another 2.57 billion euros tranche of its three-year bailout program should serve to remind of the incredible level of capital it will have to repay in the future, the economic pain the nation will have to suffer to reach fiscal targets and the inequity of countries with higher debt costs having to bailout this particular nation. To add to the precarious picture, Greece is scheduled to auction off short-term bills. Then there is the Basel III capital ratio. There is a reason Germany has loudly rebuffed calls for higher reserves and a five-year implementation; because this and other European nations are the furthest from meeting the suggested targets. If the bar is raised, European banks (dependent on ECB liquidity) could be forced to raise more capital and suffer painful yields.

If we are looking for the spark to feed fear of a financial crisis or accelerant to an economic slowdown, we have an entire fuse box in Europe. However, speculators’ attention is a fickle and unpredictable thing; and they can remain unfocused for longer than we would expect. So, we must wait. In the meantime, it will be worthwhile to keep an eye on scheduled event risk to see if there any volatility to be had from the docket. The top tier data for the period is Tuesday’s investor sentiment survey’s imperative to establishing the market’s tolerance for the region’s financial instability. One step down, we have Eurozone employment and inflation for the ECB to consider as bearings for monetary policy. After that trade, industrial production and factory prices will struggle to garner attention.

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