EUR/USD Weekly Outlook 7/6 thru 7/11 2008

This will be our first "back to normal" week following the ECB's rate decision and the incredibly thin conditions due to the U.S. markets being closed for holiday.

In my view, higher risk is on the EUR this week and there's a slight advantage on the USD and a greater probability we see further downside on the EUR. What happens between market open today and Tuesday could very well set the tone for the remainder of the week and the short-term trend of the EUR/USD.

In case you missed it Trichet delivered a speech early this morning and was more on the hawkish side... Trichet was defending his decision to raise rates 25bps and was taking the position of protector against Europe's poorer citizens. I'm not so sure the markets will quite follow that logic...

Sarkozy did give a much more even response saying that he supports the ECB's independence and policies but feels that rates should be lower because the U.S. has lowered their rates.

I believe this comment from Trichet at the post-rate press conference will still be fresh in the mind of traders:

"Today's decision will contribute to achieving our objective."

It is this comment that sent the euro on a 200+ pip dive against the dollar and it is this comment that could potentially keep the euro pressured against the dollar.

Fundamentally we have a light week. The biggest fundamental data this week will be German Industrial Production, ECB economic bulletin, Pending Home Sales, Trade Balance, Crude Inventories, and the Michigan Sentiment.

With only a few big reports on the books, the Fed and ECB will take center stage this week. Bernanke speaks twice with one of them being a testimony on market regulation. You can be assured he'll be questioned on more than this and will be questioned on current monetary policy while the opportunity is there to do so. Trichet will speak three times this week and is widely expected to defend his position and to remain hawkish on price stability.

All eyes will be on the two central banks this week as the markets will be looking for any and all signals that point to future monetary and rate policy moves in the near-term.

EUR/USD:

Last Thursday's sharp correction and Friday's continued euro weakness is worth noting even though market conditions were thin and the move was fueled by profit-taking and stoploss triggering.

We've seen the euro make repeated attempts at a sustained break above 1.5800, 1.5850, and then 1.5900. All were resoundingly rejected. As I mentioned in the last update it would be important to see the euro close above 1.5724 on Friday. This didn't happen.

The euro made one final attempt at that level on Friday and within minutes had dropped about 50 pips to the downside. Should thin market conditions persist at the start of the week it's highly likely the bears will remain in control and will seek further downside testing.

Fundamentally there is no reason at all for the dollar to make any substantial gains against the euro. There's been zero fundamental change in the market the past two weeks with exception of the ECB raising rates 25bps.

If you take a logical approach to the market, with an ECB rate hike, and with the euro trading under 1.5700 these should be excellent levels to buy at for the potential of 100, 200, or 300 points worth of profits.

Our market rarely operates on logic, though. It's runs on pure emotions... it buys the rumor, it sells the fact...

In general, price action patterns of the EUR/USD will almost always move to the downside at a much faster and more exagerrated degree. All you need to do is pull up a chart and calculate the time it takes the euro to move up 200 points vs. the time it takes to move down 200 points and you'll clearly discover prices slide faster and more forcefully to the downside as opposed to the upside.

There are very specific reasons why this happens. I won't take the time to explain that here, maybe in a future price action post, but I want you to be aware of this price action pattern and to keep a watchful eye on the euro's real-time price action this week, especially at the start of the trade week.

We're still several hours away from market open, but I do have some overall key levels you'll want to be aware of...

Upside: 1.5724, 1.5748, 1.5767, 1.5788
Downside: 1.5662, 1.5641, 1.5628, 1.5607

At this poin I'm more biased to see additional downside testing. A sustained break of the 1.5580-1.5560 level could easily open the doors for the market push down another 120-220 points... of course the market correlated variables will come into play addition to what the market is showing us with the real-time price action.

It's imperative we watch the USD Index this week. In terms of support, 72 and 70 are key levels. In terms of resistance 73 and 75 are key levels. As always, gold and oil will be back in play. Is this the week oil runs out of steam and corrects below the $132 level? Will gold run out of steam and fall dramatically below $910? We have to watch close...

And as far as rates are concerned, we have to watch the 2-year and 10-year yields... when the euro pushed up last week U.S. bond yields fell and German bund yields rose which only further fueled the euro's rise.

With the market remaining at a heightened level of uncertainty at the start of the week I caution you to use strict risk and money management disciplines until there is more clarity and more sense is made.

It's quite possible we can remain stuck between 1.5300 and 1.5800 for the next few weeks, but lets allow the market to get back in the groove on Monday and Tuesday and see what the price action is telling us.

As always, be smart with your trades and don't overleverage.