Euro Traders will Turn to Financial Troubles with the Bull Spell Broken

Euro Traders will Turn to Financial Troubles with the Bull Spell Broken

Fundamental Forecast for Euro: Bearish

- The German economy expands at its fastest pace on record in the second quarter

- Spain’s Prime Minister hints at relaxing austerity, Slovakia breaks the unity in stabilizing the region

- EURUSD posts a remarkable reversal; but is this correction destined to develop into a trend?

With the US dollar advancing for five consecutive days, the euro would naturally tumble for five consecutive sessions. For EURUSD, this decline was the worst performance the market has seen since mid-May. As the most liquid pair in the currency market, this benchmark is also a bellwether for the rest of the euro crosses. This is an unfortunate connection for the shared currency; because the substantial move of the past week has speculative and technical connotations as a long-overdue correction after a persistent and slow two-month advance. However, the sharp reversal has its fundamental bearings as well; and this underlying sway over investor positioning is what will truly define the euro’s progress going forward.

For the euro, there are two primary fundamental concerns going forward: whether the economy will expand faster than its peers (and fast enough to forgo additional fiscal troubles) and the threat of another financial crisis. As for speculation surrounding interest rate potential, the ECB has more or less written off any possibility of a hike for the foreseeable future; so don’t expect the Euro Zone CPI numbers to do much for price action. Between the two dominant themes, financial uncertain holds the greatest potential for the future. Officials didn’t fix their problems after Greece raced towards default and the market closed to sovereign bond auctions in the region. They merely offered a temporary patch that was whole-heartedly dependent on investor optimism. It is this precarious position that is exposed through developments that show a lack of progress with curbing deficits and surviving austerity. Of great concern last week (but generating only minimal attention) was the hint made by Spanish Prime Minister Zapatero that he may ease austerity efforts to support growth and Slovakia’s vote not to send bailout funds to Greece. There was already considerable doubt that the region could balance fiscal responsibility with reasonable growth before. Should unity break down in the effort to restore confidence in the entire European economic and monetary union, the currency will surely suffer.

With risk in mind, we cannot predict what will catalyze fear or confidence as there are few scheduled indicators that have this level of influence and no specific meetings to set rest our expectations upon. That being said, it will be important to keep a constant vigilance on underlying risk appetite trends market wide. Should the need to unwind risky positions wash over the markets once again, the euro will very likely be at the top of the list due to its fundamental troubles. A more specific concern to keep track of is the European governments’ ability to access the debt market. Spain, Ireland, Portugal and Hungary will all attempt to raise funds next week. Consistently high yields and low demand will eventually capsize confidence.

Looking at the economic docket, there is little reason to believe that we will see even a short-term trend develop from any of the scheduled listings. However, the ZEW sentiment surveys for Germany and the Eurozone should be noted. As a confidence reading for investors, this data will be important for gauging the market for sovereign and regional bank bond auctions before they actually take place. - JK