EUR/USD Weekly Outlook 6/29 thru 7/4 2008

I’m searching for words to describe the risk potentials this week holds but I don’t think I can come up with anything strong enough and alarming enough to underscore how critical this week is.

This week’s risk level: 10

What is at stake this week is fundamental data and central bank monetary policy potentially setting the near-term trend of the EUR/USD. This will be a make or break week for the euro or the dollar. All the power is in Trichet’s hands. Trichet holds the destiny of the EUR/USD and he will decide which direction the EUR/USD moves in the near-term.

All markets are 100% focused on the Fed, the ECB, Bernanke, Trichet, and interest rate policy. The Fed and ECB have been toying with the markets the past month. Bernanke and Trichet have been dueling with words and rhetoric to either support or debase their respective currencies.

A month ago Trichet told the markets he was raising rates 25bps on July 3. Shortly after, Bernanke fooled the markets into thinking he was an inflation fighting super hero and that his Fed was going to raise rates at the end of summer. Next, Trichet started to diminish market expectations of an ECB rate hike in July. Then, Bernanke flip flopped and changed his tune on inflation and on interest rate policy. The end result of the Fed and ECB games was the euro closing last week a stone’s throw from 1.5800.

During the past month’s pissing match between Bernanke and Trichet we saw gold and oil make renewed topside gains, we saw the yields on the 2-year and 10-year top out and head lower, we saw Fed Funds Futures diminish their probabilities of Fed rate hikes, we saw U.S. equities take beat down after beat down. We saw more credit and money market issues emerge. We got more lies from the Fed about inflation

Now, this week, we can forget about everything we’ve seen and heard the past month. It’s up to Trichet to decide the fate of the EUR/USD. It’s really simple – the markets are expecting a 25bps rate hike from the ECB on Thursday and their expecting to hear a hawkish Trichet at his press conference.

If Trichet makes good on his promise and raises rates 25bps I fully expect the EUR/USD to test the 1.6000 level or better in the near-term. Should Trichet fail to deliver on his promise of a 25bps and make no change to the ECB’s key lending rate I fully expect the market to sell off the euro and we should see a return test of the 1.5300 level or better in the near-term. It’s really that simple.

That being said, I do not want to discount or diminish the importance of this week’s fundamental data because it will move the market before we get Thursday’s ECB circus side show. We have tremendously critical economic and fundamental data this week… all week long… inflation, manufacturing, production, growth, employment, and consumer data for the U.S. and Eurozone will be released this week – all rate sensitive data.

Tomorrow:

We get things kicked off right away with CPI data out of the Eurozone. Expectations are running high for a hot print on this number. Should we see a hot print or even an expected print you can be sure the market’s will hold to their opinion that Trichet is raising rates on Thursday and this will be a good catalyst to see more euro gains early in the week.

I don’t see any reason why the CPI data should print cool. There’s no evidence of this. Be warned, should this CPI number surprise to the upside and print at 4.00% it’s very probable we’ll see a strong upside move in the euro on Monday.

The other big fundamental event on Monday is the Chicago PMI data. I’m not forecasting a USD+ print on this data. Should Chicago PMI print at or below expectations this will get the market thinking that the more important ISM data will print to the downside on Tuesday and will further fuel any losses the dollar is receiving at the hands of the euro.

NFP:

If an ECB rate decision and Trichet press conference wasn’t enough we also get NFP on Thursday, plus the newest unemployment data. At this early point in the week the forecasts for NFP are all over the place. Economists are forecasting anywhere from -43K to -60K. Some are forecasting upward revisions to last month’s data while others are forecasting downward revisions.

My thinking is this… if the ECB raises rates or if they shock the markets and don’t raise rates, NFP will likely take a backseat to the ECB no matter what. Now, should the ECB not hike rates and we get USD+ NFP data, hang on to your seats because it will be a wild ride…

EUR/USD:

There is substantial risk to both the EUR and the USD this week. At the beginning of the week all the risk is clearly on the USD. I strongly urge against adding new EUR/USD shorts. Adding new EUR/USD shorts is not at all in my game plan at the beginning of the trade week. There is too much risk on the dollar to try and buy it up.

It is imperative that we closely track and follow the market correlated variables in addition to the fundamental data, the Fed, and the ECB. Last week ended with the Dow getting pounded into the ground, with oil making new all-time highs, with gold making a renewed push north, and with bond yields dropping off their best USD+ levels.

All market correlated variables are working against the dollar and working for the euro at the present. Price action remains clear to the upside. This week’s fundamentals favor strong gains in the euro and more losses for the dollar. As I said, the fate of the EUR/USD is in Trichet’s hands at this point…

I told you last Sunday that gold would come back into play and this surely was the reality. We hadn’t heard much from gold but it came back with a vengeance in last week’s trading. Guess what’s going to come into play this week? The good old USD Index…

The past two weeks the USD Index has been relatively quiet and rangy. One main reason the USD Index has somehow stayed fairly USD supportive is because the yen and the swiss haven’t made substantial gains against the dollar the past two weeks. This could all change. The euro carries the most weight on the USD Index but should we see the pound, the yen, and the swiss all move against the dollar along with the euro this will push the USD Index lower and just cause the dollar to extend its losses to a greater degree.

Should we break below the 72 level on the USD Index this could potentially signal a test of the key 70/68 level. Should the ECB fail to deliver a rate hike and should the market correlated variables turn around in favor of the dollar, we could see a test of the key 74/75 resistance levels. Keep an eye on the USD Index this week please…

Trading and Risk:

I’m begging all traders to establish their risk and money management plan for how they are going to handle the potential chaos… establish your risk and money management plan now! When will you trade? When will you not trade? What size entries will you make? What will you do if the ECB doesn’t raise rates? What if they do raise rates?

What if there are U.S. bank failures this week? What if there’s a surprise geo-political event this week? Think about these things… consider these factors… think about the risks, the probabilities, and the potentials.

If your risk appetite cannot handle the potential volatility, sit on the sidelines. If you’re an emotional train wreck this week will could send you over the edge. For me, I love this chaos, I love the insanity. I feed off it and thrive off it. The more chaotic the market is the more sense it makes to me, but not all traders are this way, and that’s fine, but you have to trade under the conditions that best suit you.

As far as trading goes, I’m looking at much higher probabilities of euro gains early in the week. Adding new EUR/USD shorts is certainly not in my game plan at the start of the week. I’m holding open all euro swing longs I have at 1.4595 on up until further notice.

You know the potentials this week holds, you know the risk this week holds. Be smart, don’t over leverage, and don’t make knee-jerk and emotional trades.