Fundamental Forecast for the Euro: Neutral

An action-packed week left the euro at the highest level in almost a month after Greece successfully passed a new deficit-reduction plan – a scheme including tax hikes, spending cuts, and government asset sales – to pave the way for the disbursement of a critical tranche of EU/IMF aid in August as well as a second bailout worth 110 billion that ought to tide the country over through 2014. A largely ceremonial meeting of EU officials will officially announce the new plan after a meeting on July 3, but its passage seems to be all but assured after Greek Prime Minister George Papandreou braved political suicide to secure his end of the bargain and pushed through the austerity plan amid raging riots. While throwing more money at the Greek problem will certainly solve none of the country’s structural problems, the threat of an imminent default has been neutralized and a bit of celebratory Euro buying was logical enough.

All is not well in the outlook for the single currency however, as markets begin to look past the Greek crisis that so dominated financial circles in recent days and are reminded of the shaky macroeconomic landscape emerging in the second half of the year. Last week as a case in point: indicators of manufacturing sector activity from across the world’s leading economies – which are typically good early indicators of where overall growth is headed over the near term – proved largely disappointing. Chinese factory-sector growth slumped to the weakest post-Great Recession level, the final revision of the analogous reading for Germany – the leading European economy – downgraded the pace of activity from an already alarming initial result, and a similar gauge from the UK printed dramatically below expectations. The US ISM manufacturing gauge was a conspicuous standout, snapping a three-month losing streak and posting an increase despite forecasts calling for another decline.

Needless to say, this makes for a conflicted outlook. One month of accelerating US manufacturing growth against a backdrop of an increasingly pronounced overall down trend both in the States and elsewhere is not enough to say that all is well. And yet, strong performance in the world’s largest economy promises positive spillover elsewhere considering the US is a heavy importer, so a genuine acceleration there (if one is indeed underway) would drive demand and boost growth for other countries as well. A firm reading on where global growth is heading is critical for the Euro as prices remain closely geared to overall sentiment trends, with EURUSD showing a formidable correlation with the MSCI World Stock Index (a reflection of investors’ outlook for corporate earnings worldwide, and thereby a proxy for global growth expectations).

From here, traders will need concrete evidence that the US has indeed turned a corner, with all eyes on next week’s Employment report. If that yields another rosy outcome, the swell in optimism seen last week will get a boost, driving the Euro higher along with share prices while the safe-haven US Dollar is sold. Needless to say, a disappointing result would reverse this dynamic. Meanwhile, the European Central Bank is widely expected to raise interest rates by another 25bps on Thursday. The move has been priced in for weeks, with a validation of existing expectations unlikely to produce significant fireworks. On the other hand, an unexpected decision to hold off given the precipitous slide in Euro Zone economic data over the past month would weigh heavily on the single currency.

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