Fundamental Forecast for Euro: Bearish

For three weeks, EURUSD steadily climbed while the other dollar-based majors struggled for meaningful direction. This comparison alone should tell us that the responsibility for this specific pair’s performance fell not to the dollar but to the euro. Indeed when we look at EURJPY, EURGBP and the rest of this shared currency’s crosses; we see the same performance. This collective climb was founded not on a surge in confidence for the region and its currency but rather a sign of relief after its outlook had deteriorated so thoroughly thanks to financial, growth and yield concerns. It is important to differentiate between a rise in confidence and the moderation of fear. One naturally carries little momentum while the other can sustain its own trends. Which is which? That is an important question to ask considering the euro suffered its first real setback in three weeks this past Friday.

Establishing the source of the euro’s fundamental strength is a critical first step to analyzing where the currency will head going forward. In the rally that has established itself through the bulk of January; there hasn’t been a genuine improvement in conditions. Instead, the steady selling pressure that had developed in the months before was starting to ease up. ‘Confidence’ was found in the open-ended proposals for increasing the bailout facilities, reducing emergency loan yields, selling bailout bonds, allow EFSF debt purchases, finding the ability to intervene in the bond market and other remarkable suggestions. There is no doubt that officials have been seriously discussing these initiatives; but the likelihood that valid concerns will be put aside to dramatically increase stimulus efforts is low. In fact, we have seen adamant opposition to increasing the bailout program, selling bonds that are guaranteed by all the EU members and other controversial issues. This week, EU officials are scheduled to discuss these exact issues on Wednesday; but it has been expressly suggested by participants that few accords will be struck in this event. And, while it may seem that no agreements would be a non-event; in fact, it is a reminder that these same concerns have been circulating for some time and they have consistently butted heads instead of finding a solution. It will be hard to maintain a relief rally under that reality.

Another key, exogenous event will be the Portuguese sovereign bill auction for the same day. It was a smart move to schedule the sale on the same day as the meeting as the market will hold off from a panic while EU officials are convening on the possibility that there is some meaningful resolution that makes it through. Nevertheless, this event will still be seen as a gauge of the market’s confidence in Europe’s financial health just when doubt is starting to bleed through. And, taking stock of the skew in the market full coverage will be met with skepticism while a short-fall in demand will stoke bearish sentiment.

As for the economic docket, we will be watching for a feel for relative growth (following the US and UK GDP releases) as well as rate speculation. For growth, the German employment data, regional jobless rate and manufacturing and service sector activity figures will give a good sense of what we should expect the benchmark for the region’s GDP reading will be in the weeks ahead. Interest rate speculation – another of the key relief rally points – will also come into view. The ECB rate decision will not come to a change in policy; but we will be analyzing for any additional, subtle changes in tone. As we have seen before, even slight change can lead to significant leverage in price action.

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