Fundamental Forecast for Euro: Bearish

The euro fell sharply against the US dollar in the year’s first week of trading, setting the stage for a negative month of January and potentially further losses through 2011. The first week of the month tends to set the pace for the following weeks, and the first month of the year predicts February-December performance with impressive accuracy. Fundamental arguments for euro weakness abound, but the mere fact that it has started the year on such a weak note bodes poorly for medium-to-long-term forecasts. A busy week of economic event risk likewise promises noteworthy volatility in the days ahead.

Disappointing sovereign bond auctions and generally disappointing news out of the European Monetary Union forced considerable Euro weakness, and overall momentum favors continued EURUSD declines into the coming week’s trade. Portugal was forced to pay a significant yield premium on a six-month bond auction, and Portugal-Germany yield spreads nearly hit fresh record-highs amidst the ensuing market tensions. The European Commission likewise forced further stresses when they sad that investors may need to shoulder part of the burden in future domestic bailouts. And though their recommendations would take years to implement, the mere suggestion was enough to show that appetite for further bailouts had waned significantly through recent events.

It is increasingly becoming a question of ‘when’—not ‘if’—a country such as Portugal is forced to take financial assistance amidst poor demand for its fresh debt issuance. Just recently the Swiss National Bank announced it was no longer accepting Irish and Portuguese bonds as collateral for lending. If domestic central banks are no longer willing to accept Euro Zone periphery debt, it underlines why private investors may likewise shun risky investments. It will be exceedingly difficult for the Euro to post any sort of significant rally against major counterparts amidst such worries over the solvency of individual member states.

The DailyFX Team has largely called for Euro weakness into 2011, and the first week of sharp declines certainly supports that hypothesis. It will be critical to monitor any and all developments through the ongoing fiscal crises, and recent developments suggest little material improvement is likely. Though this hardly guarantees that the EURUSD will decline through short-term trade, we remain overall bearish and expect further declines through January and potentially the rest of the year.

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