Euro Looks Ready To Break Out On Downside. By Nicholas Hastings

Unless this week's earnings reports turn up some pleasant surprises, the euro should finally break through the bottom of its recent trading range against the dollar.

With global risk aversion still on the rise, equity and commodity prices still on the decline and concern about the euro-zone economy and its banks increasing, support for the single currency should drain away.

At the same time, talk of reserve diversification, which has been depressing the dollar, should fade now that last week's G8 summit meeting is over and BRIC nations no longer have a stage on which to parade their demands.

The G8 meeting was also instrumental in reducing market optimism over the global economy, with its warning that the recession may not be over.

Of course, sentiment could be boosted once again if second-quarter earnings from U.S. corporations this week come out stronger than expected. However, initial reports at the end of last week showed little sign of this happening.

As a result, risk aversion is expected to remain high - driven by a continued decline in equities as well as increasing evidence that demand for commodities and world trade is on the slide.

The Baltic Index is down 15% from its high at the start of June and a report in the Nikkei newspaper at the end of last week says rates on container ships have fallen to six-year lows.

"We suspect that the moves seen in shipping, metals, energy and soft commodity prices in recent weeks are a sign that the pressures that started to mount during the second quarter of this year are dissipating rapidly," said Simon Derrick, a senior currency strategist with Bank of New York Mellon in London.

All this fits in with equity prices that appear poised for a major correction, with the S&P futures back down at its 200-day moving average, a level that it has been flirting with since the middle of June.

While this rise in risk aversion should continue to play into the dollar's safe-haven hands, the euro is looking increasingly exposed on the downside.

At the end of last week, Germany's Handelsblatt was reporting that at least 10 East European countries are in negotiations with the International Monetary Fund over credit packages.

This was a stark reminder of the continued risks of default euro-zone banks face in the region.

Even before this story broke, concern over euro-zone banks was edging center stage, with German Finance Minister Peer Steinbrueck warning that the credit problems of German companies are likely to get worse later this year.

Steinbrueck went so far as to ask the European Union for a relaxation of the Basel capital adequacy rules for its banks. The request was rejected, leaving fears that a credit crunch will develop in the months ahead and stifle any hopes of an economic upturn.

For the moment, the euro may still be bouncing around between the $1.3700 and $1.4150 range that has existed since early June. But chances are that when the breakout comes, it will be on the downside as the euro once again suffers from another serious dose of global risk aversion.

Risk aversion remained very much in force early Monday in Europe, with the euro falling to $1.3928 by 0645 GMT from $1.3949 late Friday in New York, according to EBS. The euro was also down at Y128.44 from Y128.90, while the dollar fell to Y92.22 from Y92.39.

Falling stocks ahead of this week's earnings reports, as well as political uncertainty in Japan now that elections have been called for August 30, appeared to be the main drivers of the negative sentiment.