Fundamental Forecast for Euro: Bearish

The euro finished the week almost exactly where it began, confounding trend traders in an exceedingly choppy range against the US dollar. Markets initially sent the European currency considerably higher in the early going, but low volatility expectations emphasized that extended moves were unlikely. Low forex options markets implied volatility levels suggest that we may see similarly choppy but directionless price action in the week ahead, and traders should trade carefully amidst low liquidity in the holiday-shortened week of trade.

It was a week of relatively few major developments in ongoing Euro Zone fiscal crises, and range-bound price action reflected that. The last European Union summit of the year produced little in the way of major surprises. Leaders expressed their resolve to help any at-risk member countries via bailouts, but they did not expand the size of the European Financial Stability Facility (EFSF) as many had expected. Given that traders are likely too busy skiing in the Alps and far away from their trading screens, we expect few flare-ups in sovereign bond market tensions in the days ahead. Yet ongoing European fiscal crises are far from over, and January could prove eventful as markets test the stability of the European Monetary Union.

Second-tier economic data is unlikely to force anything in the way of major volatility. Yet traders should remain cautious amidst some of the most illiquid market conditions all year. Recent price action emphasizes that markets can and do turn on a dime during times of low market participation. As such, we advise traders to use lower leverage in a bid to preserve capital going into the New Year. January should prove far more eventful and is typically pivotal in setting the pace for the rest of the year’s trade.

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