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EUR/USD: Trading the Euro−Zone Economic Confidence Report

Mon, Mar 30 2009, 05:53 GMT
by Daily FX Research Team

DailyFX

Economic confidence in the Euro-Zone is expected to improve in February as policymakers step up their efforts to restore confidence in the financial markets however, as the region faces its worst economic downturn in over half a century, fears of a deepening recession could weigh on households and businesses as the outlook for growth and inflation falter.

Trading the News: Euro-Zone Economic Confidence

What’s Expected

Time of release: 03/30/2009 12:30 GMT, 08:30 EST

Primary Pair Impact : EURUSD

Expected: 65.8

Previous: 65.4

Impact the Euro-Zone Economic Confidence has had on EURUSD over the last 2 months

February 2009 Euro-Zone Economic Confidence

Economic sentiment in the Euro-Zone unexpectedly slipped to 65.4 from a revised reading of 67.2 in January, which is the lowest reading since recordkeeping began in 1985, and the data reinforces a dour outlook for the region as growth prospects deteriorate at a record pace. Weakening fundamentals paired with increased turmoil in the banking sector continues to weigh on households and business, and as the outlook for growth and inflation falter, fears of a deepening recession could lead the European Central Bank to step up their efforts as the region is expected to face its worst economic downturn since World War II. As a result, market participants anticipate the ECB to lower borrowing costs by another 50bp in March as households and businesses turn increasingly pessimistic towards the economy, and may adopt unconventional tools to stimulate the ailing economy as the interest rate falls close to zero.

January 2009 Euro-Zone Economic Confidence

Confidence in the Euro-Zone fell to a record low of 68.9 from a revised reading of 70.4 in December, and conditions are likely to get worse as the International Monetary Fund forecasts the annual rate of growth to contract 2.0% this year. Rising unemployment paired with fading demands from home and abroad has certainly dragged on the economy throughout the second half of 2008, and the outlook for growth and inflation remains bleak as trade conditions falter. The data continues to reinforce fears of a deepening downturn in the region, and the European Central Bank is expected to lower the benchmark interest further in the months ahead as price pressures alleviate.
ECB President Trichet said that price growth could reach ‘very low levels’ by the middle of the year, and as the central bank maintains its one and only mandate to ensure price stability, the board may continue to ease policy further as the downside risks for inflation intensify.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario:

If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.

Bearish Scenario:

If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.

How To Trade This Event Risk

Economic confidence in the Euro-Zone is expected to improve in February as policymakers step up their efforts to restore confidence in the financial markets however, as the region faces its worst economic downturn in over half a century, fears of a deepening recession could weigh on households and businesses as the outlook for growth and inflation falter. The preliminary GDP reading for the euro-region showed that the economy contracted 1.5% in the fourth quarter, which was the biggest drop since recordkeeping began in 1995, while the annual rate of growth slipped to -1.3% from an initial estimate of -1.2% to mark its first full-year contraction.
The breakdown of the report showed that household spending plunged 0.9% from the previous quarter, which is the biggest drop in consumption on record, and was followed by a 2.7% drop in business investments. In addition, industrial outputs in January dropped 17.3% from the previous year to mark its largest decline since comparable records began in 1986, and conditions are likely to get worse as trade conditions falter. A report by the European Union showed that the Euro-Zone’s trade deficit widened to 5.5B in January from a revised reading of 1.7B in the previous month as exports to the U.S., the nation’s second-largest trading partner, fell the most in five-years, while private spending declined for the eighth consecutive month in January, and the data continues to reinforce a dour outlook for the economy as growth prospects deteriorate at a record pace. Despite fears of a deepening recession, European Central Bank President Trichet continued to emphasize his reluctance to overshoot the interest rate during an interview with the Wall Street Journal, but went onto say that the board will ‘continue to do whatever we think optimizes our situation’ as the region faces its worst economic downturn since World War II. As result, market participants expect the ECB to continue its easing cycle in April, and Bloomberg News survey shows that 42 of the 50 economists polled forecast the central bank to lower the benchmark interest rate by 50bp to a record-low of 1.00%. Nevertheless, as risk trends continue to dictate price action in the currency markets, a rise in risk appetite would boost the appeal of the euro as investors move into higher-yielding assets.

Expectations for a rebound in confidence favors a bullish forecast for the single-currency, and a significant improvement in sentiment would certainly set the stage for a long euro-dollar trade for the given event risk. Therefore, if the index rises to 66.0 or higher, we will look for a green, five-minute candle following the release to confirm a buy entry on two-lots of EUR/USD. Once these conditions are met, we will place our initial stop at the nearby swing low (or reasonable distance taking volatility into account), and this risk will determine our first target. Our second target will be based on discretion, and in an effort to preserve our profits, we will move the stop on the second lot to breakeven once the first trade reaches its target.

On the other hand, fears of a deepening recession paired with increased turmoil in the banking sector are likely to weigh on households and businesses, and a drop in economic sentiment would lead us to sell the euro as the outlook for growth and inflation falter. As a result, if the index falls to a fresh low, we would look to short the single-currency following the release, and will follow the same setup for a short euro-dollar trade as the long position mentioned above, just in reverse.

Outlook for Growth Improves - Stronger Than Expectations

Confidence Falters – Lower Than Expectations

Published on  Mon, Mar 30 2009, 06:04 GMT