Euro Weakness May Continue, If US GDP Figures Fail To Revive Risk Appetite.

EUR/USD

The Euro continues to lose ground after failing to hold above 1.5000 as a sharp pull back in risk appetite and concerns over global growth weigh on the single currency. Risk sentiment continues to explain 56% of price action for the pair making it imperative for traders to monitor potential influences on equity markets. Although the ECB and Fed aren’t expected to raise rates over the near-term, the outlook for future monetary policy from the central banks has started to grow in importance as we get closer to 2010, it is widely expected that at some point next year both will begin tightening.

ECB Interest Rate Expectations

ECB interest rate expectations sharply fell over the past few days which added to the prevailing bearish sentiment.  Overnight Index Swaps are pricing in 89 bps worth of rate hikes over the next twelve month which is down from the peak of 101.5. German unemployment data tomorrow could influence yield expectations, as a strong labor market in Europe’s largest economy could raise inflation forecasts.  Rising wages is a main driver of broader inflation and a primary concern for policy makers. Euro-zone sentiment readings and German retail sales will provide the temperature of the consumer and the potential of domestic growth. Continued signs that the recession has permanently gone away will shorten the timetable for future tightening.

FOMC Interest Rate Expectations

Fed funds futures are currently pricing in a 3.8% chance of a rate hike by the end of the year which is down from 6.5% a week ago. An unexpected 3.6% drop in new home sales raised concerns that absent government stimulus the recovery in the housing market will falter. It will make it prohibitive for the central bank to raise rates if home values continue to fall. A 1.0% gain in durable goods orders was a sign that growth is starting to gain traction on the back of manufacturing activity which could lead to a upside surprise in the upcoming U.S. third quarter GDP figures.  Early forecasts are for a 3.2% surge in growth which could accelerate the timetable for rate hikes from the Fed.

Risk

Stock markets are continuing their descent from 10,000 with the Dow looking on track to test trendlne support. Therefore, we may see continued weakness until this level is reached which could translate into more losses for the EUR/USD. The weak housing data is a concern for traders which may negate any potential positive impact from the backward looking positive U.S. GDP figures. However, traders should be alert that the U.S. Senate is attempting to extend the housing tax credit throughout 2010 which could reverse the negative impact that the dour housing data had on stocks. Regardless the broader trend is favoring risk aversion which is a negative for the Euro.

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com