Euro/US Dollar - Why the Decline May Not Continue For Much Longer

Normally I discuss the euro and US dollar separately, but trade in the currencies rely so much on each other that today, it seems worthwhile to talk about them together.

We’ve seen that the US dollar remains strong across the majors, especially the euro and Japanese yen. Was there strong US data on hand? Nope. Hawkish comments from a Federal Reserve member? No. So why did the dollar gain? Bearish outlooks for the Euro-zone.

Indeed, this morning, the EU said that the robust growth seen in the Euro-zone “has come to an end” as they revised GDP forecasts for 2008 to 1.3 percent from 1.7 percent, while raising inflation forecasts to 3.6 percent from 3.1 percent. Meanwhile, the EU warned of a “significant downward revision” to 2009 forecasts, as “global headwinds” intensify and the financial system remains “fragile.” Furthermore, despite comments from ECB Executive Board member Juergen Stark saying otherwise, the EU said they saw “no evidence of widespread” second-round inflation effects stemming from commodity price gains earlier in the year, suggesting that the ECB will be more likely to cut rates in the future. Credit Suisse overnight index swaps (OIS) are pricing in nearly 50bps worth of reduction by the ECB within the next 12 months, which leaves the odds in favor of a EUR/USD test of 1.40, especially since OIS price in over 25bps in increases by the Federal Reserve during the same period. Nevertheless, according to COT forex positioning, the dollar is extremely overbought and the euro is oversold, suggesting [B]we may be nearing a point where risk/reward warrants selling the greenback[/B]. With US event risk picking up in coming days (US Import Price Index on Thursday, US Producer Price Index and Advance Retail Sales will hit the wires on Friday), indications of softer inflation pressures or weakening consumption could trigger a reversal.

[B]Related Article: US Dollar Still Strong on Expectations the Fed Will Raise Rates, ECB Will Cut - But When?

Check out Daily Fundamentals in its entirety for analysis and outlooks on the US dollar, euro, British pound, Japanese yen, and the commodity dollars.[/B]