Fundamental Forecast for the Euro: Bearish

If we were to gauge the euro’s current strength through a lens focused months into the future; the currency would very likely tumble as the possibility for a clean resolution to Greece’s troubles and avoidance of further trouble for the rest of the Euro Zone is highly unlikely. However, the market is neither rational nor constrained to specific time frames. As we have seen many times over the past weeks and months, short-term relief to deteriorating fundamental conditions has spurred significant gains for the shared currency. In the coming week, we have numerous opportunities for last-minute reprieve. On the other hand, there is an inevitable tipping point where the promise of further rate hikes from the ECB will no longer be able to compensate for growing risks. And, that moment may come sooner than many are prepared for.

Heading into the new trading week, the top concern is once again Greece. Europe’s debt troubles are spreading beyond this particular spendthrift economy; but the likelihood that another EU member faces as serious shocks as Greece is low. As such, we will be watching for headlines from this particular country as a catalyst for deeper concerns. This past week, region averted another potential crisis. After EU Finance Ministers failed over the weekend to agree to the next round (tranche) of aid for Greece, investors were anxiously awaiting the results for the nation’s confidence vote. In the end, Prime Minister Papandreou retained his position at the head of the government; and the market’s took it as a sign that avoiding a default is possible.

In reality, this move does little to improve the odds for a debt collapse going forward. More important are the votes scheduled in the week ahead. First, the Greek parliament is set to vote on the medium-term budget (new austerity measures included) by the 28th. EU officials have said that this is a prerequisite to receiving the next round of support (and it is likely to pass). From there, European officials will need to approve the 12 billion euro tranche. Then they will need to move on to the July 3rd vote where the discussion will turn to a second possible bailout package for Greece. It has been suggested that the IMF may not even continue to fund the initial 110 billion euro bailout. Furthermore, authorities will need to encourage all private holders of the nation’s debt to willfully role their obligations five years.

Even if all of these hurdles are cleared, it would still be very difficult for Greece to survive its debt burden (from both a financial and social perspective). Yet, these long-term troubles may not even be necessary as breaking points for the euro going forward as the persistence of financial troubles in the region along with a cooling in global growth have lowered risk appetite on a global basis. Should investor confidence collapse, it will fully expose the Euro Zone’s financial troubles and render financing the already struggling EU members (Ireland, Portugal and perhaps Spain, maybe Italy) nearly impossible through bailout efforts.

The cumulative troubles that the euro faces are tremendous; but as we said above, the market can often focus on short-term returns that relegate the more distant concerns to the backburner. The scheduled Greece-related events should certainly be monitored; but they are likely to end with short-term patches that give us no guidance for direction. The real risk comes through underlying sentiment trends. And, for that, we will watch the performance of the capital markets (equities and speculative commodities) as well as liquidity measures.

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