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The euro has been the big mover of the session dipping to fresh 2-year lows below 1.22. The low so far today has been 1.2170 (EBS rates) as Spanish bonds have ended their rally and Italian yields have started to rise even after a successful bond auction earlier this morning. Not even better than expected China data (loans rose to 919.8bn yuan in June, up from the 793.2BN yuan in May) could thwart the drop in risk sentiment.

Is China to blame for the falling euro?

So what soured the mood for the euro? The political and economic back-drop has been weak for a while, and apart from some slightly better than expected industrial data for the currency bloc (which fell 2.8% in May versus a decline of 3.2% expected) there was no fundamental trigger for the push lower in risky assets like the euro. Instead we believe Chinese data may have weighed on the single currency. Its FX reserves for June were lower than expected at $3.24 trillion, versus $3.35 trillion expected. This is roughly in line with reserve levels for most of this year; however it confirms that reserves are not growing in China. This is a problem for the euro for a couple of reasons: 1, it suggests growth could be topping in the Asian powerhouse (we will find out more when tomorrow's Q2 GDP figure is released) and 2, (more importantly, in our view) central bank reserve diversification out of dollars and into the euro has been a major prop for the single currency in recent years. Now that FX reserves are showing signs of topping this support may start to falter.

Why is this important now when we have known about the China slowdown for some time? It's because of the euro is facing a perfect storm, which includes less official support from abroad as well as economic and political challenges at home. Combine this with a rate cut from the ECB and the euro looks like it is on very fragile foundations.

Weekly close pivotal for EURUSD

The euro is looking incredibly vulnerable in the near-term. Below 1.2180 the next key support zone is 1.2150, which then opens the door for a move to the all-important 1.20 level. EURUSD is starting to look oversold on a short-term basis, thus we may be sticky around the 1.2150 level and could even pull back towards 1.2210 in the short term. The weekly close tomorrow is going to be pivotal for the future direction of this pair, in our view. A close below 1.2150 could open the way to a move towards 1.20 next week.

The dollar is flying today as safe havens surge. The Aussie has been a major victim and is down 1.5% after risk aversion and a weak employment report hurt AUDUSD. Below 1.0125 opens the way for a move towards 1.0020 then parity. However, this pair is also starting to look oversold on the short-term charts, so we expect some stickiness on the way to 1.0100.

Is there anything that can break the fall of the single currency? Since the euro is moving closely in line with risk anything that can boost market sentiment could help the euro. Right now there are global growth concerns and sovereign concerns weighing on the euro, so any improvement on these fronts could boost sentiment. Thus, Chinese GDP tomorrow could be a key driver for markets. The markets expect a decline to 7.9% from 8.1% in Q1, watch out for any upside or downside surprises.

Relative rate differentials driving the market

Relative interest rate differentials are also a key driver of markets at the moment, and after the BOJ failed to boost the size of its balance sheet at its meeting earlier today and the FOMC remains on hold then the yen and the dollar are winners, not only because they are safe havens, but also because their central banks did not join the global liquidity fest started by the ECB, BOE and PBOC last week. Thus, it's hard to see the yen or the dollar giving back gains any time soon.

Watch out for initial jobless claims later, as a weakening labour market could push the Fed towards more QE, which may weigh on the dollar. Also, we have our eye on the SPX 500. Futures point to a weaker open, and this index is at risk of falling through 1,340 - the 50-day sma support. Below here opens the way to 1,300 - the 200-day sma - and a steeper decline.

Data Watch: US session

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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