European financial assets have continued to reflect optimism over the future of domestic growth, as equity markets and bond yields continue trending higher through recent...

... trade.

This bullish outlook has seemingly escaped the domestic currency,
however, as the Euro has fallen nearly four percent off of Decembers 18-month
highs against the US dollar. Many Euro bulls hope that tomorrows German ZEW data
may provide the much-needed spark to drive the currency off of recent lows, but such
an outcome greatly depends on the actual ZEW survey figures. According to consensus
estimates, markets expect that Economic Sentiment a measure of outlook for the
following 6 months will rebound to its best print since September. German
investors have consistently proven bearish on the future of economic growth, but a
previous bounce off of 13-year lows suggests that the worst may be past us. As such,
we will watch for a further retracement for the headline Economic Sentiment index,
with risks remaining to the upside for domestic equities, bond yields, and the
European currency.

Bonds - Euro Bund (German Bond) Future

German bonds prices have remained on a fairly clear downtrend, as a bullish outlook
on the European economy has forced traders to reconsider investments in domestic
debt. This is most clearly visible in Bund Futures, with the March contract just
several points above its previous 5-month lows. All of this is enough to suggest
that investors are expecting economic data that will continue to impress, and
tomorrows German ZEW report is no exception. A positive outcome would likely push
Bund prices further off of recent lows, boosting yields and the attractiveness of
the Euro as a higher-yielding currency.

FX - Euro vs. US Dollar

The extended weekend for the US markets has effectively taken the steam out of the
EURUSD pairs decline. With plenty of time to fundamentally position themselves
and consider technical levels, the benchmark pair could be set for a strong move.
All that is lacking now is a trigger. Looking ahead, tomorrows German ZEW survey
of investor confidence may offer the perfect catalyst for a move be it a rebound
or an extension of Januarys sharp slide. As of the most recent revision to
predictions, the consensus for the report calls for a pick up in the Expectations
component, while the Current Situation figure cools. The outlook for the German
economy has been heavily depressed going into the end of 2006 specifically due to
the planned sales tax hike that took affect on January 1st. In November, the
uncertainty surrounding this policy change reached a flash-point after the outlook
component marked a 13-year low. However, since then, investors have begun to revalue
their dour expectations for economic activity as a deluge of positive data has
suggested consumers are well positioned to weather the burden of a 19 percent sales
tax. In the year through 2006, estimates show Europe’s largest economy topped a
six-year high. Furthermore, unemployment has reached a four-year low while consumer
confidence has subsequently marked a five year high. Now, as the tax hike finally
takes effect and the markets start to measure the pressure on economic functioning,
euro traders will see whether their projections in previous months were overblown.
Should the indicator surprise to the upside (especially on the current and
expectations reads), the presence of support around the 1.29 figure will act as a
spring board for bids. On the other hand, if the bleak expectations prove warranted,
then EURUSD may find the impetus for an eventual move to 1.25.

Equities - German DAX Index Futures

German equities, like their global brethren, have relentlessly appreciated over the
past months. In fact, by the close of Mondays session, the benchmark DAX Index
was able to mark a new, nearly-five year high. Equities have been firmly bid as
domestic and foreign investors look to take advantage of economic growth at six-year
highs. Already, this growth has shown clear benefits for both the business and
consumer side of the economy. Consumers have been rewarded with unemployment at
four-year lows and competitive wages. Alternatively, German firms have enjoyed
demand from strong domestic consumption, as well as growing orders from outside the
national boarders. In November, factory orders grew 1.5 percent as industrial
production accelerated 1.8 percent. Going forward, the ZEW confidence indicator
could be key in defining the future direction in equities. Already, the DAX has
shown signs that its steady ascent is hitting pockets of sell orders. This may be an
indication of institutional selling. Should the investor sentiment survey print a
disappointing number, it may catch retail and international investors off guard and
trigger a wave of panic selling. Conversely, if the indicator proves investors are
confident the economy and the consumer will weather the sales tax hike, money
managers and investors still holding money on the sidelines may enter the market
with the belief that a top is not yet in sight.


Regards,

John Kicklighter
Forex Capital Markets
32 Old Slip, 10th Fl
New York, NY 10005
Email: jkicklighter@dailyfx.com

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