Fundamental Forecast for the Euro: Neutral

I was tempted to set the euro’s fundamental forecast to ‘Bullish’ for the coming week; but a critical fundamental concern kept me from doing so. This is an unusual outlook given my general bias for the health of the shared currency is very bearish over the span of weeks and months. Yet, the forecast for our purposes in this article is only for the coming week; and my concerns are not yet shared by the broader market as there is still enough yield and expectations for higher rates to delay the inevitable reconciliation between risk and reward. On the other hand, if investor sentiment itself sours; a suddenly scrupulous market would most likely deem the euro a considerable risk given the lack of stability the Euro-area’s financial market’s face.

If we are to see the trends of this past week extend into the trading days ahead, the euro will most likely carry its advance. This climb is burning quickly because the buildup in selling pressure through May has found relief with a quick (and inadequate) solution to Greece’s financial crisis. The country’s troubles were finally coming to a head with the next traunche of the country’s original 110 billion euro bailout due; and certain officials warning that the EU member did not hit the required targets to trigger the aid. What’s more, both the market and officials have come to terms with the reality that Greece would be unable to return to the market in 2012 as originally planned with the yield on the 10-year bond at twice the rate (16 percent) we had seen when the rescue program was initiated. However, all of this was temporarily pushed back with the immediate problem of Greece’s next support check with the ‘Troika’ giving the nation passing marks on its review (though it many are skeptical that these benchmarks were actually met).

There are still prominent risks to this blissfully ignorant approach to fundamentals. The greatest threat is that the market is no longer placated by officials’ standard assurances that all is okay and financial allies begrudgingly offering just enough support to buy a little time. The same strategy of minimal progress has been used for so long; that investors will eventually realize that it has not led to a sustainable solution. Yet, the market needs a little extra motivation to come to this understanding. From within the Euro Zone, the undetermined outcome for what additional support Greece will receive (though the EU’s Juncker has said the group has agreed to additional aid), is a glaring issue. Beyond that, it is very likely that Portugal and Ireland will demand further accommodation given their respective governments’ shift away from bailouts and EU-imposed austerity. Outside factors are perhaps more immediately concerning. If risk appetite collapses (as the S&P 500’s distended bull trend threatens), a harsh review of troubled currencies will find the euro wanting.

While the headlines about financial health and the improbable mathematics of a clean recovery burden the ‘risk’ aspect of the euro, we will see the ‘reward’ side of the currency illuminated by rate speculation surrounding the ECB’s rate decision. The conclusion of the discussions will be delivered on Thursday; but market and economist expect the outcome to be no change to the benchmark rate or support facilities. That does not mean it will be a wash by any means though. With this particular announcement we will also see growth and inflation forecasts updated from March. These figures along with President Trichet’s commentary will guide speculation as to when the next move will be. At the moment, there is a considerable discussion of a July hike; but current financial conditions don’t do much to support this timeframe. In a split market, there is inevitably a large group that finds itself on the wrong side of the market.

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