My medium- to long-term view on the euro (FXE) is bearish, as I discussed in my previous articles here and here. This was also the marketplace consensus view and the price trend seen since last April to July. Over the last few months, the most dominant factor in the EUR/USD cross has been sovereign risk, particularly the Eurozone sovereign debt crisis.
The single currency has reached its lowest value relative to the dollar in July, when Spain was under the spotlight and its sovereign bond yields reached their highest levels. Following remarks from the European Central Bank (ECB) president, Mario Draghi, that he would do whatever was necessary to preserve the euro, risk premiums have dropped sharply and the euro appreciated more than 4% against the USD.
However, in the short term there remains a lot of uncertainty and will take place a series of events that could lead the euro either way, and can change my medium to long-term view or further support it.
At the end of this week we will have the Jackson Hole symposium, where Bernanke is expected to give new hints of further monetary easing. The minutes of the last Federal Reserve meeting imply that it would take a big and rapid improvement in the economic data, to stop the Fed implementing further quantitative easing. Although Bernanke should not explicitly announce what the Fed will do, in the past he has used the Jackson Hole speech for giving a very strong signal.
Following the Jackson Hole conference, where Mr. Draghi will not be present, there is the ECB rate decision on 6 September. Although a rate cut isn't expected, because it would leave the overnight deposit rate on a negative level, the ECB should give more details about its bond-buying program. If the ECB decides to expand its balance sheet without limit to put a cap on Spanish and Italian bonds yields, it can be a game-changing solution to the Eurozone debt crisis and be very positive for the euro.
On 12 September, the German Constitutional Court will rule on the legality of Germany's participation in the European Stabilisation Mechanism (ESM). The ESM is a central piece in the European debt crisis solution framework and a positive decision is expected. The alternative doesn't seem reasonable, as it can lead to the destruction of the Eurozone because it would mean that Germany wouldn't stand behind other Eurozone countries' debt and the route chosen by Europe's politicians would be seriously compromised. If the German court decides otherwise, it could be very negative for the euro.
Spain will be certainly also a key catalyst, as the bailout speculation continues to increase and the auditors will be announcing the results of their investigation into the support needed for the Spanish banking sector. Spain has some fundamental issues to resolve and the risks of more bad news are clearly negative for the euro.
Other events will also take place over the next month, but in my opinion will have less impact on the EUR/USD movement. This includes the Fed meeting at mid-month, as Bernanke will most likely pre-announce Fed's next movement at Jackson Hole, the elections in the Netherlands, the Eurozone finance ministers meeting or the troika report on Greece's progress over its adjustment program.
If history is any guide, there is a considerable risk that European authorities won't solve any issues in the short erm, leading to a new risk aversion environment. This should encourage the USD to strengthen further, as the greenback continues to be seen as a safe currency.
Indeed, if the Eurozone debt crisis deteriorates further, this could ultimately lead to a break-up of the monetary union, and the downside for the euro would be huge and EUR/USD parity or lower would be likely. This can be avoided if the ECB delivers on its promises, but given the German opposition to the bond-buying initiative, I think what the ECB will present is likely to fall short of expectations.