Fundamental Forecast for the Euro: Neutral

Another week of pronounced financial volatility produced sharp swings for the Euro/US Dollar exchange rate. Yet the single currency finished almost exactly where it began and continues to trade near multi-month highs. A busy week of event risk and a potentially pivotal US Nonfarm Payrolls report threaten similarly large moves in the week ahead.

Substantial rallies in the Dow Jones Industrial Average should have left the correlated EURUSD higher on the week, but it seems the link between risk sentiment and the euro currency has diminished as of late. In fact, the euro seems mostly decoupled from most major asset classes and has traded in a choppy consolidation pattern since setting multi-year highs in May. EURUSD charts show the pair at the top of an ascending wedge formation since mid-July; the next move could prove pivotal.

For Europe, traders will keep a close eye out for key German Employment figures as well as inflation data. There is also a highly-anticipated speech by European Central Bank President Jean Claude Trichet due Saturday (August 27) that could force moves in key European assets. Concerns over Euro Zone fiscal crises seem to have hit a lull as recent ECB bond purchases sent Spanish and Italian bond yields sharply lower. Yet the single currency zone is hardly out of the woods yet, and markets will keep a close eye out for references to future ECB policy moves.

The future of European Central Bank monetary policy remains a focus as traders increasingly price in ECB interest rate cuts through the coming months. Overnight Index Swaps previously predicted the ECB would raise rates by at least 25 basis points in the coming 12 months. Yet those same instruments now predict at least one rate cut, and the shift removes a key pillar of support for the EUR. It is admittedly surprising to see the Euro remain resilient in the face of monetary and fiscal headwinds. Yet much of the reason for its relative strength remains poor fundamental outlook for the US Dollar and other major counterparts.

To that end, markets will keep an especially close eye on upcoming US Nonfarm Payrolls data and the usual stream of NFP week economic releases. The disappointing trend in US labor figures has heightened speculation that the US Federal Reserve will soon enact the third wave of Quantitative Easing (QE3) measures and hurt the US currency. Yet a highly-anticipated speech by Fed Chairman Ben Bernanke made no reference to imminent policy moves. The US Dollar immediately rallied (EURUSD sold off), but markets quickly reversed and the EURUSD finished higher.

It promises to be another eventful week for the EURUSD. Yet whether the pair will break its multi-month range remains to be seen, and it may be particularly significant to watch EURUSD price action near frequently-tested peaks near $1.4500.

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