The main theme that is dominating all markets is the sharp moderation in peripheral Europe's bond yields. Portuguese, Spanish, Irish and Greek bond yields have all fallen, while German bonds (the Eurozone benchmark) have risen as a result of lower safe haven flows in the aftermath of the successful Portuguese bond auction yesterday, and this morning's Spanish auction of 5-year bonds, which saw a bid-to-cover ratio of 2.1 times.
News that European authorities are looking at a number of measures to bolster the financial resources available for the weaker states is also encouraging. An extension in the size and scope of the Eurozone rescue fund, which currently stands at EUR440bn, will apparently be supported by Germany, according to the latest reports. Markets seem to be giving the European authorities the benefit of the doubt and hopes are building that a long-term crisis resolution mechanism will be agreed upon in the coming weeks and months.
Narrowing yield differentials between the peripheral nations and Germany have boosted the euro. EURUSD smashed through the 1.3080 level, a significant area of resistance, and is currently around 1.3150. This has been a strong rally and we could see back to 1.3250/60 if the upward momentum remains. However, the single currency is still vulnerable to sharp pullbacks. As mentioned above the weight of expectation is now on EU officials to come up with a credible plan to build the infrastructure necessary to help Europe's most indebted nations. If they fail to do this the market's faith could be lost very quickly and the euro could tumble. So the fate of the euro rests with the decision makers in Brussels. Next week's eccofin meeting will be the first test of the Eurozone's will to make permanent changes to its structure in the wake of the sovereign debt crisis.
Elsewhere, the Swiss National Bank vice president said that he was concerned about the level of the Swiss franc and the effect of the Eurozone crisis on his country's currency. The SNB conducted a costly round of FX intervention in 2009 to try and depress the Swissie to little effect, so it is unlikely they will do so again. Instead they seem to be pursuing a strategy of verbal intervention after the official dismissed reports that the CHF could be pegged to the euro. A stronger Swissie hurts exports and can depress inflation by reducing the cost of imports, which worries the Swiss authorities. They will be hoping that the strong run for the single currency continues, but EURCHF is still nearly 14 per cent lower than it was a year ago, so there is a long way to go.
Central Bank meetings will be in focus today. The Bank of England and the ECB are both expected to remain on hold; however ECB President Trichet's press conference at 1330GMT will be of most interest. The market will be trying to gauge his reaction to the Portuguese and Spanish bond auctions, and whether he thinks they were a success. Trichet will likely remain tight lipped about whether the ECB intervened in the markets to help depress peripheral bond yields prior to this week's auctions, but he will probably be pressed on this matter by the press corps. Traders should look out for whether or not the ECB is worried about inflation pressures after CPI rose to 2.2 per cent in December. In the past Trichet has said that inflation expectations in the Eurozone remain well anchored, it will be worth watching out to see if he repeats this comment this afternoon.
UK manufacturing and industrial production data was slightly higher than expected. However, the strength in EURGBP, which has risen nearly 1 per cent this week, has caused GBPUSD to stall. Overall, the dollar is weak across the board and the dollar index is down more than 1 per cent this week. This is boosting equities and commodities. Brent crude oil is up more than 5 per cent in the last four days, gold has also moved higher though it appears to be stalling above $1,380 per ounce. The FTSE is struggling to keep up with its European counterparts, after retail giant Tesco's pre-Christmas sales update missed analyst expectations due to the snow.
The ECB press conference will most likely dominate markets this afternoon, before the focus shifts to the US where Federal Reserve President Ben Bernanke is scheduled to speak at 1800GMT and inflation data for December is released tomorrow.
12.00GMT (0700 ET) UK MPC Interest rate decision Last 0.5
12.00GMT (0700 ET) UK QE Target Last 200 bio Exp 200 bio
12.45GMT (0745 ET) EU ECB interest rate decision Last 1.0 Exp 1.0
13.30GMT (0830 ET) EU ECB Press Conference
13.30GMT (0830 ET) US Initial Claims Last 409K Exp 410K
13.30GMT (0830 ET) US PPI Last 0.8 M/M 3.5 Y/Y Exp 0.8 M/M 3.8 Y/Y
13.30GMT (0830 ET) US Core PPI Last 0.3 M/M 1.2 Y/Y Exp 0.2 M/M 1.4 Y/Y
13.30GMT (0830 ET) US Trade Balance Last -38.7 bio Exp -40.5 Bio
14.00GMT (0900 ET) EU Schauble speaking
17.30GMT (1230 ET) US Commerce secretary Locke Speaking on the US Commercial relationship with China
18.00GMT (1300 ET) US Bernanke Speaking
19.00GMT (1400 ET) EU Stark speaking
23.50GMT (1850 ET) JP Corporate Goods Index Last -0.9 Exp 1.0
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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