Last week, the euro and pound both had their largest single week declines since the height of the EuroZone Debt Crisis as the euro dropped about 600 pips and the pound dropped about 500 pips.  Look at the velocity of last week's sharp decline.
 
 Note: Past performance is not indicative of future results.

Note: Past performance is not indicative of future results.
In our analysis at the beginning of last week, Coming Attractions for This Week In the FX Market, we discussed the strong possibility of a decline in euro and pound last week due to the combination of very weak fundamental reports out of the U.S., U.K., and China.  Sure enough, both pairs sold off quite sharply last week, but the sell-off was really strong.  In classical technical analysis, the sell-off was much sharper than we would want to see in a corrective wave if the uptrend is still in place.  Thus, the question now is, Is the uptrend still in place in EUR/USD and GBP/USD, or is last week's sharp decline the beginning of a new downtrend?

 Why Did The Euro Fall?

The simple answer is that no one is really sure.  The pound's fall was expected last week.  During June and July, when it became very evident that the United States economy was slowing significantly and Federal Reserve would not be raising interest rates in 2010, the pound began appreciating rapidly versus the Dollar as investors priced in the probability that the U.K. would hike rates much sooner than the U.S.  However, in late July Bank of England Governor began speaking very dovishly concerning the economic recovery in the U.K., and then in early August he sealed the deal when he all but said the U.K. would not be hiking rates in 2010.  This served to remove the incentive for the pound to appreciate rapidly versus the Dollar, and, therefore, the GBP/USD fell sharply.

The euro, however, does not have the same backstory as the pound.  While it is apparent that the U.K. recovery is slowing down and facing major obstacles similar to the U.S. recovery, the EuroZone recovery seems to be moving along nicely.  The EuroZone Debt Crisis seems to be completely under control as Greece, Portugal, and Spain have adopted strict austerity measures in order to reign in government spending and slash budget deficits.  Last week, Germany released GDP figure of 2.2% growth, which was nearly double market expectations of 1.3%.  The number was a huge surprise to the upside, which was definitely not expected in light of the weak economic progress in the U.S., U.K. and China.  However, the euro still managed to sell-off even in light of this fantastic news from Germany.  This fact has us concerned about possible further weakness in the euro and confirms our view that a major bout of risk aversion may sweep through the markets this fall.

If the euro fell as sharply as it did with German GDP blowing market expectations out of the water, what will happen when bad news begins to surface in the EuroZone?  And most economists believe that bad news will begin to surface in the coming months as austerity measures begin to weigh on the economic recovery in fragile economies such as Greece, Spain, and Portugal.  When bad news begins coming out of the EuroZone and mixes with a bleak outlook in other developed nations, it could spell disaster for the euro.

Major News Releases For This Week

Due to pretty limited major news events this week, we could see the FX Market move into a bit of consolidation as market participants digest last week's movements and attempt to formulate a game plan as the fall trading season comes into view. 

Euro

There is really only 1 major news release for the euro all week, and that is German Economic Sentiment on Tuesday.  The figure is expected to dip slightly from last week, but the continual flow of positive data that has come out of the EuroZone in the last few weeks may help the Sentiment figure surprise to the upside.  A surprise to the upside should further bolster investor confidence in the EuroZone recovery and help the euro fight off lower levels.

The most important news for the euro this week, however, will be anything unexpected.  Late last week Greece was in the headlines again as the media began to shine a spotlight on the struggling economic recovery in Greece.  If the recovery falters even more, expect the euro to face great pressure.

United States

There is no major news out for the U.S. this week.  However, the steady flow of reports such as PPI, Unemployment Claims, and Philly Fed Manufacturing Index should help shape overall investor sentiment.  If these reports continuously come out negative next week, it will serve to weaken investor sentiment further and that could help to bolster the U.S. Dollar as investors continue their run into safe-haven assets.

U.K.

Retail Sales and CPI should give investors a strong clue concerning the true state of economic recovery in the U.K.  Retail Sales are actually expected to decrease from last month.  If this figure surprises to the downside, it could be disastrous for the pound.

This week is set to possibly be a quite week in FX, but surprises to the upside or downside could cause strong volatility to return to markets.  On Sunday evening, Japan released a GDP figure that was quite atrocious at 0.1%, which was far below the market expectation of 0.6%.  This negative number out of Japan will only serve to further weaken investor sentiment and if combined with other negative news on Monday and Tuesday, could cause strong risk aversion to pull the euro and pound down further.