Fundamental Forecast for Euro: Bearish

The euro set fresh 9-month high against the US Dollar, but a late-Friday reversal warns that the single currency may be on the cusp of a much larger correction following substantial gains. US Federal Reserve Chairman Ben Bernanke sent the euro and other major currencies significantly higher against the US Dollar on a speech in which he openly discussed the need for further monetary policy accommodation. The Chairman’s thinly-veiled references to Quantitative Easing confirmed market suspicions and forced the USD lower, but it is interesting to note that the Euro was unable to hold its gains and actually finished the day below its open. Given such a bearish single-day reversal, we suspect that the EURUSD may have set an important top in its sharp push towards 1.4150 through Friday morning trade.

An important week of German and broader European economic data should dominate event-driven moves for the EURUSD, but we suspect that the trajectory of the US S&P 500 and financial market risk sentiment will be the primary drivers of EUR trends. Traders should watch for any especially large surprises out of often market-moving German ZEW business confidence data, German and Euro Zone PMI results, and late-week German IFO Business Climate survey responses. That said, the medium-term correlation between the EURUSD and the US S&P 500 trades quite close to an all-time high. Thus it will be perhaps more significant to gauge whether major equity indices can hold their substantial year-to-date gains.

Forex futures and options positioning remains heavily in favor of Euro/US Dollar rallies, but the potential for a bullish sentiment extreme warns that any corrections could be especially sharp. We have admittedly been humbled in our premature calls for a US Dollar reversal. Yet the combination of extremely one-sided sentiment and a sharp single-day reversal considerably increases the odds of a larger EURUSD pullback. Given that currencies tend to set their highs and lows for the week on Mondays and Fridays, it should be especially interesting to watch Euro/US Dollar price action to start the week’s trade.

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