Fundamental Forecast for Euro: Bearish

The euro finished the week almost squarely where it began, sticking to a wide and choppy range despite being among the worst performers in an uneventful week of price action. A fresh downgrade to Portugal’s sovereign credit rating elicited little reaction, but the ongoing theme of fiscal debt crises looms large in the New Year. An effectively economic calendar and illiquid holiday trade makes major moves in the week ahead fairly unlikely, but traders should control leverage amidst risk of outsized intraday choppiness amidst limited market participation.

A fluke 80-pip rally in the EURUSD in late Thursday trade warns that markets can shift direction on a dime, and traders should manage risk accordingly. Mid-week German Consumer Price Index data is the only piece of foreseeable event risk on the ledger, and it would likely take a substantial surprise in either direction to force any real Euro volatility. Thus we will likely spend the rest of the year reflecting on the most important themes for 2011 and preparing for likely more eventful price action in January.

Seasonal tendencies have shown that the month of January tends to set the pace for the full year of trade across currencies and equity markets alike. A 60-year study in the US S&P 500 (1950-2009) has shown that January performance predicts the direction of performance for February-December in 44 out of 60 years. In other words, a loss or a gain for the month of January has predicted the same from February-December with 73.3% accuracy. Using synthetic euro/US dollar rates back to 1980, the same ‘January effect’ predicts performance about 70 percent of the time. Suffice it to say, we will keep a close eye on euro and S&P 500 performance in the first month of the New Year.

DailyFX provides forex news on the economic reports and political events that influence the forex market.