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Euro Selling to Resume as Weak Growth Outlook Compounds Debt Crisis

By , Currency Strategist
12 November 2011 01:42 GMT
Euro_Selling_to_Resume_as_Weak_Growth_Outlook_Compounds_Debt_Crisis_body_Picture_5.png, Euro Selling to Resume as Weak Growth Outlook Compounds Debt CrisisEuro_Selling_to_Resume_as_Weak_Growth_Outlook_Compounds_Debt_Crisis_body_Picture_6.png, Euro Selling to Resume as Weak Growth Outlook Compounds Debt Crisis

Fundamental Forecast for the Euro: Bearish

The Euro ended the trading week on a bright note, posting the largest daily rally in two weeks and trimming its weekly loss to just 0.2 percent on average against the major currencies. Optimism emerged after Greece finally settled on Lucas Papademos – at one point the Vice President of the ECB – as its new Prime Minister, while Italy abandoned plans for disruptive early elections in favor of a technocrat transition government headed by former EU Commissioner Mario Monti. The news stocked hopes that the emergence of coherent stewardship will speed the passage of austerity measures and placate jittery financial markets, lightening the debt burden on both countries by bearing down on borrowing costs.

Looking ahead, this chipper mood is unlikely to prove lasting. While the passage of deficit-reduction plans is certainly a step in the right direction, their effective implementation is what investors are truly concerned about. So far, Greece has proven to be an excellent case study of a country that promised a lot but delivered little, failing repeatedly to meet the budget benchmarks set by its saviors at the EU and the IMF. With that as their base-line scenario, traders are unlikely to expect much more of Italy, at least initially. Indeed, even if one assumes the best-case scenarios will play out, it is going to take some time for the newly-minted Monti and Papademos administrations to prove themselves to skeptical investors.

Over the near term, the tone will be set by Italy’s austerity vote over the weekend. The Senate has already sounded off in the affirmative, and now the Chamber of Deputies (the lower house of Parliament) is set to hold a poll on Saturday. Approval seems overwhelmingly likely and may extend the recovery in risk appetite into the early part of next week, but such an outcome seems to have been priced in to a significant extent already and the spotlight will promptly turn to practical matters of execution. In fact, the first test of the markets’ confidence comes as soon as Monday, with Italy scheduled to auction off €3 billion in 2016 bonds. The uptake for the securities, including any buying from the ECB, as well as the prevailing yield levels will be closely watched to gauge Italy’s ability to sustainably refinance its obligations.

Against this backdrop, a worrying set of economic data releases is likely to fan the flames of risk aversion as traders are reminded that sluggish growth inherently undermines the ability of Euro Zone governments to trim deficits by stunting tax receipts. Preliminary third-quarter GDP figures from Germany as well as the currency bloc as a whole are on tap, with both reports expected to annual output growth rates slowed to the weakest since the first three months of 2010, which marked the first period of positive growth since the Great Recession. Meanwhile, Germany’s ZEW survey is forecast to yield the lowest investor confidence reading since November 2008. – IS

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12 November 2011 01:42 GMT