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The market had been hanging on the long-term Italian debt auction today and it wasn't the success yesterday's short-term auction suggested it could be. Although yields fell Rome only managed to shift EUR 7bn, lower than its EU 8.5bn target.

The timing of the auction was fairly bad for Rome as it's difficult to see who would want a tonne of Italian debt on their balance sheet at year-end. The debt auction's results were mixed, with the shorter 2014-dated bonds failing to attract maximum offers, although yields fell from 7.89% last month to 5.62%. Longer term debt also saw its yield drop, with 11-year bond yields falling to 6.98% relative to the7.56% last month. This is below the crucial 7% mark, but only just, and it highlights that the situation in Italy remain precarious.

Italian PM Monti is just starting his end of year speech right now, where he will present his economic plan for 2012. He has started by pledging stable debt reduction next year; however he has said no more budget cuts are needed. While public spending needs to be cut to reign in Italy's debt load, Monti has to navigate a treacherous path whereby he cuts spending just enough to reign in debt but not too much to choke off growth.

This has spooked investors and risk assets have come off as EURUSD tests 1.2900 and stocks pare some of their earlier gains. Today's auction in Italy reminds us that stresses remain, and although today's debt was always going to be a hard sell as it comes at the end of the year, Italy has a mountain to climb next year, as it tries to sell EUR 400bn of debt - half of which needs to be sold to merely re-finance its original debts. So as we end the year we are reminded on the many stresses that could weigh on the euro going forward. 1.30 looks a long way away today, however don't underestimate the resilience of the single currency. Although we think its trajectory is lower, it could be a slow grind to the mid 1.20's by March, rather than a sharp decline.

The dollar is strong across the board today, which is having a negative impact on the commodity sphere; Brent crude is testing $107.65 support - the 100-day sma. However, oil could remain volatile as Iran ups the pressure over the straits of Hormuz. Arabic television stations are reporting that Iran has dismissed US warnings about its actions there. Gold is also sharply lower.

The yellow metal has remained weak after falling through its 200-day sma before the holidays at $1,630, the next support of note is $1,500 per ounce, but gold is close to entering bear-market territory as it is down nearly 20% since its peak at $1,900 in early September. In other words, US stock markets have outperformed gold, considered a safe haven, while the crisis in Europe has notched up a gear over the last 5 months.

US stocks have had a mixed performance this year. The SPX 500 is down 0.64% as of today on the year, while the Dow is up 4.6% this year, when the rest of the world is a sea of red. US economic data does have the power to change market sentiment and today there are some releases of note including pending home sales for November, which are expected to show their second month of gains. Initial jobless claims are expected to jump higher to 375k from last week's 364k - the lowest level since 2008. However, this is still below the key 400k mark. Added to that we have a Chicago Purchasing Manager survey due at 1445GMT/ 0945ET, which is also expected to moderate to 61.0 from 62.6, although this may not be as bad as it sounds since it could be due to production halts caused by the Christmas holidays.

Right now the markets are not moving in unison. The euro is taking the brunt of weak European sentiment, and is lower against the USD and JPY, and EURJPY is getting very close to that 100.00 level, without a peep from Japanese authorities. So could our Q1 target for EURJPY of 98.00 be reached sooner rather than later?

Stocks are fairly static and Italian 10-year bond yields are lower, although this is on the back of rumoured ECB buying.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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