Fundamental Forecast for Euro: Neutral

The euro hit fresh multi-month highs amidst a considerable improvement in European sovereign debt markets, defying expectations and becoming the top-performing G10 currency in the five-day stretch. Surprisingly robust demand for periphery debt and strong economic data sets the stage for continued strength, but it will be important to watch for results of future debt auctions amidst heavy supply from at-risk countries. A recent Wall Street Journal article points out that January euro zone bond auctions have been supported by increased investor cash flow that may slow considerably through February. Upcoming debt auctions may prove to be important litmus tests on market confidence, while an ostensibly busy economic calendar could likewise provide catalysts for sharp EURUSD moves.

Debt auctions from Italy, Spain, Slovakia, and Spain will likely command attention in the days ahead, while German consumer confidence and inflation figures could likewise spark euro moves on strong surprises. Overall momentum suggests that the euro could continue higher against the recently-downtrodden US currency. In fact, recent CFTC Commitment of Traders data shows that Non-Commercial traders— most often large speculators—are once again net-long the Euro/US Dollar as of January 18. This is a significant shift in sentiment and underlines that trends are anything but clear, and such indecision is often a recipe for volatility through short-term trade.

The DailyFX Team broadly called for euro weakness in 2011, but January has proven to be a challenging month for our forecasts and generally establishing lasting currency trading biases. We certainly have no problem admitting when we are wrong, but January is not yet over and there are a lot of things that can happen between now and the end of the typically critical month.

According to a previous study, a EURUSD rally or decline in January predicted a similar February-December move approximately 70 percent of the time (synthetic EUR rates are used prior to 1999). Thus we will watch the coming weeks with great interest and likely shift our biases accordingly. The recent weeks of EURUSD strength seems to have been largely a function of aggressive short-covering and not necessarily a secular shift in sentiment. Time will tell whether this is truly the start of a broader euro uptrend and a continuation of a multi-year US dollar decline, and investor confidence in euro zone fiscal solvency will likely play a large role in setting price trends.

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