Euro_Risks_Weighted_to_Downside_Ahead_of_ECB_NFPs_body_Picture_1.png, Euro Risks Weighted to Downside Ahead of ECB, NFPs

Fundamental Forecast for Euro: Neutral

The Euro continues to struggle despite more signs of improved growth.
ECB will hold on Thursday – press conference is especially important.
Regardless of ECB, US NFPs on Friday will have the last word on EURUSD.

The Euro was the second to worst performer on the week, outgaining the Australian Dollar by a mere +0.24%. With risk-aversion gripping the globe amid rising tensions between the United States and Syria, the traditional “safe havens” found their place as the top performing currencies covered by DailyFX Research. The EURUSD dropped by -1.21% to close the week at $1.3220; and the EURJPY eased by -1.78% to ¥129.80.

Declines haunted the single currency as further signs of improved growth prospects in the region failed to attract buyers. Considering that the Euro has remained elevated for the past several weeks but has thus far struggled amid stronger data, it appears that the Euro – and Europe on the whole – has become a short-term safe haven from plunging emerging markets.

While the emerging market fears aren’t going to go away anytime soon, it’s clear that the risk to the Euro is weighted to the downside: strong data is failing to inspire further gains; and even slightly disappointing news is attracting sellers more commonly. This week, with the first revision to the 2Q’13 Euro-Zone GDP report due and no change in the report figures (+0.3% q/q expected unch; -0.7% y/y expected unch), it is unlikely the Euro sees a boost on the organic-data side of the equation.

This secondary theme – that the Euro isn’t rallying on signs of a broader recovery – will exhibit itself multiple times throughout the week amid the final August PMI readings due for the Euro-Zone’s major economies. Like in the case of the GDP figure on Wednesday, these data, despite their positive inclinations, will do little to spur upside momentum.

Indeed, there are two headline themes this week, one at home and one abroad for the Euro. On Thursday, domestic issues come front and center when the European Central Bank will unveil its latest policy decision. A hold is expected all around, with the main rate at 0.50% and the deposit facility rate at 0.00% – duly no cut to a negative interest rate. However, the first theme – the intensity of ECB President Mario Draghi’s discussion on inflation and credit growth – could prove to be a negative influence on the Euro.

The ECB, like most central banks in developed economies, relies on inflation as a temperature reading of economic activity; and when the thermometer is at +2% yearly, that’s when the ECB finds its polices are working best. When inflation is at +2% yearly, economic growth is moderate, but not too fast to spur runaway prices; and moderate inflation means the central bank can keep interest rates lower to support credit growth. That is why this past week’s round of inflation data is so concerning for the Euro, notes Currency Strategist Ilya Spivak.

I agree with my colleague but I think the implications are more geared towards credit growth rather than inflation; Germany, after all, despises inflation and is certainly cheerful that hyperinflationist fears haven’t manifested themselves amid seemingly endless monetary easing.

Credit growth was a main concern for ECB President Draghi at the last post-meeting press conference, despite signs that growth had turned higher (it has, and credit growth remains weak). Indeed, a look at Euro-Zone excess liquidity shows that capital levels have fallen back to pre-LTRO1 levels, which of course precipitated liquidity injections totaling over €1 trillion beginning between December 21, 2011 and February 29, 2012. So, while the ECB may not want to cut rates again given the near-term pick-up in growth prospects, it may be thinking about implementing another liquidity injection to help spur credit growth (which would hurt the Euro).

While the ECB addresses credit growth, the US labor market report – the hallowed NFPs – will guide the US Dollar. Ultimately, when all is said and done, the US Dollar will guide the Euro. Given the sensitivity of markets to September taper talk, forex traders will likely find that this Friday’s US NFP report will upend the Euro – quite possibly violently in either way depending upon the print. –CV

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Source: Daily fx