Fundamental Forecast for Euro: Neutral

- European Union members continue to issue debt at exorbitant rates; but investors ignore this concern
- Germany’s IFO Business sentiment survey provides the euro temporary fundamental footing
- How far can EURUSD run? After forging four-month highs, overhead resistance has lightened up

For those that follow the macro trends behind the currency market, it is difficult to reconcile the euro’s remarkable climb to new highs with the lingering financial and economic troubles that this economy continues to face. Nonetheless, the currency managed a week-end rally against its benchmark counterpart (the US dollar) Friday to close at its highest level in five months. Now, with EURUSD standing just below the highly visible 1.3500 psychological level (and 50 percent Fibonacci retracement for you technical traders), there is a distinct bite of speculative momentum to the otherwise remarkable two-week bullish bias the market was already touting. However, traders are a flippant crowd; and considering the euro is leveraging much of its performance on the sentiment of the crowd, forging further ground when the unit is already at such extraordinary highs will carry with it exceptional level risk.

There are a few primary drivers that can sustain or undermine the euro’s performance going forward. One uncertainty that seems to have lost much of its potential influence over future price action is the financial predicament individual EU members and the region as a whole faces going forward. Though there are few scenarios going forward where the euro-region will find itself unscathed in its fight against budget deficits balanced against slowing economic activity, market participants are proving to defer to the here-and-now rather than concern themselves with what lies further down the road. This is fortunate for bulls as it diverts attention away from lingering concerns over Portugal’s lack of progress on cutting its own budget gap (the government recently upgraded its deficit assessment) and Ireland’s liability in preventing Allied Irish from sinking its entire financial system. Helping to remove an otherwise consistent threat, there are few scheduled sovereign debt sales by the most troubled EU member economies. Italy has penciled in three consecutive days of auctions and Spain is on the books for one.

If we want to ascertain the euro’s bearing and pace, the best place to look is the dollar. Or, more specifically, we should be looking at EURUSD. Though the shared currency has shown significant progress against many of its counterparts (positive sentiment arguably helps this particular currency the most because investor concern was the cause of its deterioration), a considerable share of its strength can be ascribed to the outflow of capital from the greenback. Investors are moving out of the dollar (or more precisely Treasuries and other dollar-based assets) for fear that the extraordinarily loose monetary policies the Fed has adopted will devalue the nation’s assets. For bulk investment funds and reserve assets, liquidity is essential. Naturally EURUSD being the most liquid currency pair and considering Europe maintains one of the most open markets in the world, it is a natural destination for capital.

As for scheduled event risk, the docket is loaded with notable market-movers and subtle backdrop performers. If we are looking for short-term volatility, the German GfK consumer confidence survey, CPI and unemployment change figures all have a level of prestige. If we want to follow long-term trends, we will look to the M3 figure as an objective inflation gauge and EZ sentiment readings for growth potential.

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