Heading into Q3 2011 the outlook for the EUR/USD pair appears more negative than previously anticipated.

The ECBs decision at the beginning of this month to hold its key interest rate steady for the month of June, combined with rumors that Greece was considering exiting the European Union, sparked a massive selloff that resulted in a nearly 500 pip drop over a two day period. This news sent the EUR/USD pair plunging below the lower bound of its most recent channel and sent the pair below its 20 day and 50 day moving averages. As contagion fears sparked by worries regarding Greeces ability to finance its debt begin to resurface, traders will be keeping focus on Eurozone officials strategy for managing Greeces debt obligations. Uncertainty created by the failure of Eurozone officials to implement a convincing strategy will put heavier selling pressure on the Euro and could pull it below $1.41. If the EUR/USD pair falls below $1.41 it would enter a new trading range marked by resistance at $1.41 on the upside and support at its 61.8% Fibonacci retracement level (tracing from its 2009 high to its 2010 low) at $1.39 on the downside. Taking recent SSI data into consideration, a fall below $1.41 seems more likely than a rebound and subsequent resumption of the uptrend. After all, regardless of whether the strategy to manage Greeces debt requires restructuring, reprofiling, or another EU/IMF bailout, none of the options will be met with pure optimism. The first two options will enhance fears of contagion and a financial debacle that could lead to a second financial crisis, whereas the latter option will be met with political unrest and opposition in Germany where sentiment has already revealed a high opposition to another Greek bailout. As Eurozone officials debate which optionor combination of optionsis best fit for Greece, an increase in uncertainty associated with any delayed or unconvincing course of action will likely outweigh the positive effects of further interest rate hikes. After all, further interest rate hikes would only worsen the situation with Greeces debt obligations, and any optimism surrounding such hikes will likely fade into the backdrop of the PIIGSs bond troubles. Nonetheless, as these issues become more relevant within the next three months, traders should watch for any move below newfound support at $1.41 which could lead the EUR/USD pair to test its next major support level at $1.39. On the US side, news affecting the EUR/USD pair appears to be relatively stable. Though the debt limit has officially been breached, investors have almost ignored the data as it seems almost certain that politicians will act soon enough to prevent a debt default. In regards to interest rates, there seems to be few surprises that could shake the market as the Fed has made it clear that it intends to keep its commitment to low interest rates until the beginning of 2012. Any surprise that could result from an increase in interest rates would be associated with the ending of QE2 and increases in interest rates on dollar denominated assetsas occurred with the ending of QE1. However, this would only lead to an increase in the demand for the USD and would lead to further declines in EUR/USD pair. As nonfarm payrolls continue to exhibit greater strength and the CPI continues to stay within expectations, one should expect for the dollar to remain stable against the Euro over the next three months, if not strengthen. Ruling out an extension of the Feds QE program that would result in the initiation of QE3, the most likely surprises that could occur in regards to interest rates in the US would most likely lead to further gains for the dollar. Thus, if the Fed were to choose to hike interest rates earlier than expected from surmounting pressure over rising gasoline and food prices, one could expect for the dollar to strengthen against the Euro and possibly push the pair below $1.39 and take it into a new trading range with support at the 50% Fibonacci retracement level of $1.35.

Ultimately, I predict that by the end of the next three months the EUR/USD pair will be trading near the top of the $1.39-$1.35 trading range at around $1.38. Heightened fears of debt contagion in the Eurozone will continue to drag the Euro lower against the dollar, and uncertainty stemming from any delay in Eurozone officials development of a strategy to effectively deal with the debt crisis in Greece will accelerate the Euros decline. Continued strength in American nonfarm payrolls combined with rising gasoline and food prices will put pressure on the Federal Reserve to allow for its quantitative easing programs to officially end in June and not continue with the initiation of QE3. The end of the Feds quantitative easing program in June will lead to potentially higher interest rates and will also increase expectations that the Fed will raise interest rates according to plan, effectively eliminating speculation that a QE3 program is yet to ensue. Continued strength in the US economy combined with the end of QE2 will push the dollar higher against the Euro, and Greek debt fears will lead to further strength ultimately pulling the pair to the trading range defined by its 61.8% and 50% Fibonacci retracement levels. It should be noted that even if a rebound does occur in the near term, if it does not surpass the most recent high of $1.494 on May 4th, it will begin to form the right shoulder of a head and shoulders pattern which is a further bearish indicator that a significant EUR/USD decline is likely to occur. If such a head and shoulders pattern does form, I believe it is even more likely for the EUR/USD pair to be trading within the $1.39-$1.35 range rather than within the $1.41-$1.39 trading range.