The Euro has staged a formidable run against the U.S. Dollar for several weeks.  Once the EuroZone released official word that bailout funds were in place for struggling member countries in case of a sovereign default scare, reassured investors began bidding the Euro up from a low of 1.1876 on June 6^th to a high of 1.2687 on July 7^th.  This 800+ pip run in barely a month has suddenly run into major resistance no several fronts.  First of all, there is quite heavy technical resistance in the 1.2675-1.2700 area.  Second of all, and perhaps more importantly, the Euro is beginning to run into major fundamental resistance.  There are 3 major roadblocks preventing the Euro from moving higher, and each of these is important enough in its own rite to send the Euro spiraling downward yet once again.

Short History of the Euro

The incredible decline of the Euro from November to June was the direct result of Portugal, Italy, Ireland, Greece, and Spain (PIIGS) facing the very real possibility of not being able to pay back creditors-sovereign default.  To make matters worse, once these rumors began gaining traction as a very real possibility, these countries, especially Greece, were unable to raise funds in private markets because of two main reasons.  First of all, many investors were no longer interested in holding debt from these countries, so demand quickly dissipated and the countries could not find willing purchasers of their bonds.  Second of all, the investors who did remain and were willing to purchase these bonds were now demanding a much higher interest rate, which, of course, meant much more expensive borrowing costs for these already struggling countries.  As these two elements weighed upon struggling member countries, the threat of sovereign default increased until the EuroZone released official word that funds were in place to guarantee all member countries in case of default.  This brought temporary reassurance to market participants and brought confidence back to the Euro, at least to a degree, as the Euro formed a bottom at 1.1876 before beginning its strong rally back up to 1.2700.  Now, we are at a breaking point.  Let us examine the three major roadblocks in more detail.

Bank Stress Tests

The future value of the Euro lies heavily in the hands of the European Bank Stress Test Results.  The EuroZone has decided to follow in the steps of the U.S. by deciding to conduct stress tests on major banks throughout every member country.  Basically, tested banks will be subjected to simulated financial environments that will evaluate how well each bank is able to cope with dire financial pressures during times of great economic distress.  Various reports have stated that banks will have to take a 17% markdown of all Greek debt they are holding.  These tests will then dictate how well the EuroZone banking industry will hold up during a possible Double-Dip recession.  The bank stress tests are the European Central Bank's (ECB) way of trying to reassure investors and bring more confidence to the markets.  The primary objection from investors at this point is that the terms of the stress test are not being communicated clearly.  Many investors are worried that the tests will not adequately reflect how well the banks would be able to truly handle an all-out default from Greece, Spain, or Portugal.  If test results are poor, the Euro will tumble.  If the test results are good, but investors remain skeptical of the authenticity of the results under real market conditions, then the Euro may still face downward pressure.  Results are to be released July 23^rd.

Tightened Credit

Many investors are beginning to worry that credit markets are much too tight in the EuroZone.  These tight credit markets are making it difficult for the economy to gain footing and establish a true self-sustaining recovery.  Recent reports are indicating that credit is beginning to tighten in many member countries.  When the Sub-Prime Mortgage Crisis exploded in 2008, this was the initial reaction in global credit markets, and it is what nearly caused a complete financial meltdown.  The interbank credit market is essential to the growth of the economy, especially in times when the economy is very fragile.  Due to several factors, including banks not wanting to take on any more bad debt, the credit markets are beginning to tighten.  This is causing investors to begin doubting the ability of the EuroZone to grow at solid levels of growth as measured by GDP, and at worst, if credit markets were to begin freezing up again, it could throw the EuroZone back into a period of declining growth, which would be disastrous.  If credit markets continue to tighten, look for the Euro to find a difficult path to higher levels.

Fiscal Austerity

This is a major concern amongst investors at this time.  When the Greek Debt Crisis began to unfold in late November it became clear that the PIIGS had adopted extremely undisciplined fiscal agendas.  Government spending was at irresponsibly high levels, which caused deficits to get far out of hand.  Eventually, investors began demanding very high interest rates to hold struggling countries' government bonds.  This put countries like Greece in an even bigger hole.  It makes it much more difficult to get your fiscal house in order if you are having to pay much higher fees to borrow money.  It just puts you in a bigger hole, and this is exactly what began happening to Greece and other struggling countries.  In order to abate this fearful investor sentiment and keep speculators, or as some would call the, bond vigilantes, from making a run on weak countries, Jean Claude-Trichet began calling for all countries to adopt tighter fiscal austerity measures.  This is scary to many investors because if these already struggling economies are forced to adopt very tight fiscal measures, it could cause them to slump into even slower economic growth, or worse they could begin to enter periods of decline once again.  Thus, if Trichet continues to adamantly support the idea of fiscal tightening in Europe, look for the Euro to begin losing value.