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The relentless decline in EURUSD had looked like it was staging a mini-pullback earlier, but that proved to be short-lived. A wave of weaker economic data knocked sentiment. The final version of the Eurozone's May PMI figure was revised slightly higher to 45.1 from 45, but this is still the lowest level since mid- 2009.  But it was the record high unemployment rate that caused the biggest drop in risk assets after the jobless rate across the currency bloc rose to 11% - it's highest ever level in the euro-era. The periphery is still the most affected, unemployment in Italy rose to 10.2% in April and in Spain it remains at nearly 25%.

Bad medicine...


The rise in unemployment in Italy is interesting for a couple of reasons: firstly, job losses have lagged other southern states, partly due to strict labour laws that make it difficult to fire people. Since Mario Monti's government has attempted to reform the labour market the prospect of more job losses are on the cards. Thus, as the economies of Spain, Italy and Greece try to regain competitiveness and boost productivity, more painful job losses are likely.

But are we close to a bottom in this crisis? Economic indicators show that we are approaching the lows from the financial crisis, so when will the data turn around? Compared to the financial crisis, once Lehman went bankrupt and the US authorities stepped in it took approx. 6 months to get global economic confidence moving again. But during this sovereign crisis we don't have a plan or route out of the eye of the storm. So, as mentioned above, if there is more economic pain for people in Europe to bear it could lead to more social and political unrest, which in turn could lead to more risk aversion in financial markets. As yet there is no cushion to soften the economic pain as the ECB has passed the baton to the EU governments and the next EU summit is not until the end of June. So we could be in a limbo until 1, the Greek elections next month or 2, when the EU authorities act to stem the crisis. Thus, it's hard to see how markets can sustain any risk rally in the current environment and further selling seems likely at least until we get the Greek election result or some remedial action by European authorities.

Sentiment dips again


So after a brief respite (which has tended to happen at the start of the European open) after a couple of hours of weak economic data and some negative headlines out of the Eurozone, sentiment turned weaker before we headed into lunchtime. Yields on 10-year Spanish debt are rising back towards bailout territory, while German, UK and US bond yields continue to reach fresh record lows suggesting that risk aversion has gripped the markets yet again.

The latest political developments include the IMF apparently planning for a Spanish bailout request, and the German Finance Minister saying that it seems likely Spain won't meet its fiscal deficit target  next year - the penny drops in Berlin...

More QE on the cards for the UK


Cable has been a big loser today. It is currently below 1.53, after a much weaker than expected PMI reading for May. It fell to its lowest level in 3 years, and the components of the report were also weak. This suggests that it is not just a long bank holiday to celebrate the Queen's Jubilee that is getting in the way of UK growth, weak orders from the US, Asia and Europe are also weighing heavily on the UK's growth prospects. The new orders sub-index fell to 42.00, which was the lowest level since the bottom of the recession in 2009. This does not bode well for UK growth in Q2. This is a very deflationary report, supports more QE and is sterling negative. Although cable looks very oversold on a technical basis, fundamental and economic factors seem to be dominating at the moment. Below 1.5290, there isn't much short term support until 1.5200. The pound seems to be following the euro. Back in 2010, while the euro fell to below 1.20, cable fell to below 1.45, so there could be more downside to come.

Are payrolls the FOMC clincher?


So can payrolls change things this afternoon? The market expects a reading of 150k, but the last two employment indicators including the ADP report and initial jobless claims were disappointing, so could it be third time unlucky? A weak number could dent sentiment even more in the short term, especially if we also get a weak ISM manufacturing number later. Although the US seems to be holding up better than China and Europe, signs that it is slowing could cause another bout of market jitters and selling in risky assets. But a weak number would also put the onus on the Fed to pump more stimuli into the economy, which is long-term positive for risky assets. Thus today's number is loaded with significance as it could determine Fed policy this summer. A number roughly in line with expectations (and fairly lacklustre) is unlikely to halt the wave of selling as the market would most likely go back to concentrating on Europe's dismal situation.

Market moves:


We could be in the middle of a structural change in FX markets, with the pound and euro vulnerable to further selling. From 2001-2008 the dollar was under intense selling pressure as the euro and pound rallied. Could this be turning around? Europe needs a weaker currency to stay together and the UK is also in bad fiscal shape with the prospect of more QE on the cards that could keep rates in the UK low for even longer than the BOE currently expects (approx. 2014). Likewise, deflation is now a major risk for the weakest European states, which gives the ECB plenty of room to loosen policy for the long-term and cut rates below 1% to fresh euro-era lows. Thus, if the Fed hold's off from QE3 the dollar could benefit from its yield differential.

But for retail traders the shorter term is more important. I mentioned that GBPUSD is looking extremely weak. But in EURUSD the target is still 1.2150, which we could get to next week if we see similar risk aversion. The daily close below 97.05 in EURJPY yesterday is a very bearish development. Below 96.20 opens the way to 95.60 support. 97.10 is key resistance and a major pivot level.

NZDUSD is also testing a major level that you can see on a weekly chart going back to 2009 - when the Kiwi started to recover post the financial crisis.  It is currently below 0.75, below here could see the kiwi drop towards 0.7160- the 200- week sma in the medium term. This is an important move that has ramifications for other asset classes. The kiwi is a risky assets and a carry asset. In an environment where safe haven bond yields are hitting record lows  and there is not much yield around, the fact the market is selling off high yielding assets like the kiwi tells you much about market sentiment and fear levels, which could take a long time to heal.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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