EUR/USD Weekly Outlook 7/20 thru 7/25 2008

We have an interesting week ahead as the European economic situation will come under closer scrutiny and analysis on the back of Eurozone manufacturing, production, growth, and economic sentiment data.

On Friday the euro closed down 200 points off the all-time high which has renewed some of the sentiment and talk that the euro’s ready to fall off the cliff. I don’t exactly hold those views at this point because this week’s data could provide the euro enough fuel to make another run at the all-time high and then some.

Last Thursday we did make one attempt at sustaining a break of the 1.5800 level and that was resoundingly rejected as stops were triggered and long contracts were picked up sub 1.5800.

As far as this week’s Eurozone data is concerned, the market is forecasting mostly downside weakness with exception to some of the German data. I do think some of the German data should hold up well for the most part. The real risk to the euro comes with the IFO data and the PMI data.

It’s imperative you understand that there are other factors at play this week that have tremendous market moving potentials. Lets take a look at some of these issues and how they will potentially effect the EUR/USD between now and Friday…

Fed:

I’m not sure why this hasn’t received much attention but at the end of last week we had a few Feds running their mouth about rates and monetary policy. I suppose the dismal news out of Wall St. rained on the Fed’s parade, but listen to this…

Minneapolis Fed Stern: The Federal Reserve shouldn't wait for housing and financial markets to stabilize before it begins raising interest rates. We're pretty well-positioned for the downside risks we might encounter from here, I worry a little bit more about the prospects for inflation. We're going to want to, in my opinion, reverse some of those interest-rate reductions. I don't think there's any question about that. But exactly when depends on how things evolve from here.

Kansas City Fed Hoenig: I'm on record as being concerned about inflation.

Obviously only Bernanke can really get the markets worked up over inflation and rates but we can clearly see a shift in rhetoric in regards to interest rates and the future of Fed monetary policy. This week we get speeches by Plosser and Geithner and I’m expecting to hear both to take a more hawkish stance on inflation and we could potentially hear more talk of rate hikes in the near-term.

The Fed’s stepped up inflation rhetoric is now translating into the futures markets showing higher probabilities of Fed rate hikes in the near-term. Fed Funds Futures is showing a 76% chance of at least a 25bps rate hike before 2008 is over. I’ve been watching Fed Funds probabilities rise over the past few days and this has helped translate(among other reasons) into euro weakness after the all-time high.

Keep a close on eye on the Fed this week as the markets are watching and waiting for any signs or signals they can jump on and react to.

Europe:

In January we told you the second half of 2008 would be a rough one for the Eurozone. Back in January I was certainly not expecting a June rate hike like we got. I would have laughed if anybody had told me the ECB was going to hike this year.

But I’m glad they did hike because that only gives me more reason to stay overall bearish on the euro. Not only is the ECB going to have to take that hike back, they are likely going to have to take back last year’s hike.

Oh wait, that last hike was supposed to already be priced in yet somehow we managed to move up a couple hundred points and somehow we managed to make a new all-time high two weeks after the rate hike… hmm… I guess somebody forget to tell the market about the myth of “priced in”.

Regardless, I’m a euro bear and I will keep shorting the euro rises because I still see weakness and downsides on the horizon for the Eurozone. Economic sentiment in Europe is running at historical lows. There is recession talk in Europe now, especially in countries like Spain, Portugal, Ireland, and it’s starting to creep into Italy and France.

Germany is resilient and should remain mostly immune to the coming downsides, but should Germany succumb to the type of weakness being seen in Spain and some of the other Eurozone nations, this will do substantial damage to the euro.

The rate hike did throw a wrench in the works, but as I said, I’m thrilled they hiked and I’ll be even more thrilled if they hike again because this will only serve to make the economic downturn in Europe more pronounced and more exaggerated, and you know how our market likes to respond to these types of things… the FX market is the perfect oasis for exaggeration and over-extension…

This week’s economic data out of Europe should give us all some great clues as to how things are progressing in Europe. Last week’s ZEW data was abysmal and I believe it gives an honest echo of what I’m thinking and what I’ve been saying for the past seven months.

It’s very difficult placing an exact data and time on when things happen, especially in this beast of a market, but I believe my views will be realized soon enough and I’m happy to keep positioning myself for the turn.

Market Correlated Variables:

As I mentioned earlier, there’s many more factors at play than just the underlying fundamentals of the market. Last week oil took the biggest hit ever in one single week of trading. Oil’s massive sell-off gave Wall St. a boost, it gave the dollar a boost, and it’s kept the markets guessing and probably even more confused.

I’m not an oil trader and I’m not about to give any analysis on oil. But, the formula is simple, should oil find support and continue its bullish trend this will only serve to put downward pressure on Wall St. and the USD. Thinking logically it would seem that after last week’s tremendous sell-off crude would find some support and buyers and would make an attempt to get up and over the $132 level. Should the sell-off continue look for Wall St. and the USD to find support and make some bullish gains.

Same is true with gold. Gold closed down off its highs but I see no reason to take an overall bearish view on gold. We have some major U.S. fundamental data this week and more earnings data out of Wall St. Should the news continue to be bad this will be very supportive of gold.

The USD Index is also another piece of the component. The same support and resistance levels I’ve given you the past few weeks are the ones you still want to watch. On the downside, 70 is a major key level. A break of 70 could send it to 68 and we’d be well into “heads will roll” territory. There’s quite a bit of resistance above the 73 level but should we be able to make a clean break, the next areas of resistance will be around 74.50/75.

So far any time we’ve approached that major key level of 70 the EUR has reversed against the USD and we’ve dropped several hundred points. Keep an eye on the Index this week…

EUR/USD:

Again, I’m not ruling out another run to the 1.6000 level but in order to get there, we’re going to have to sustain a break of some key resistance levels. The first of which is the 1.5880 level.as long as we trade below the 1.5880 level, we’re not moving up, it’s really that simple.

The 1.5780 is the first that has some decent support. There will be some big stops sitting below the 1.5750 level, all the way down to the 1.5700 level. I have no idea what the “trader sentiment” is in the retail market, I have no idea what the other forums, blogs, and traders are saying.

I could careless what are saying. I need to see certain price levels get hit, tested, and see if they break or bounce and this is how I will decide to trade in addition to following the underlying fundamentals of the market and whatever the market correlated variables are doing.

I’m still short at 1.6019 and 1.5925 and will hold for now. Price action will dictate how I trade and where I decide to get in and get out. I am on alert for any bank failure news that may hit the markets. I know I must sound like a broken record but I find it hard to believe we’ve still yet to hear about any significant bank failures in Europe. Surely this news must come out at some point…

Don’t make any dumb trades before London because the whole ball game can change once London enters the market. Be smart with your risk and money management.