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Risk assets continue to get sold today and the back-drop remains fragile. The leader of the radical left Syrizia party in Greece has two days to try to form a government, thus expect anti-austerity/ anti bailout rhetoric to continue to come out of Athens today. It appears that Tsipars - the head of Syrizia - wants to hold new elections to try and win the premiership. This only extends the uncertainty about Greece remaining in the Eurozone, which spooked risk assets yesterday.
That isn't the only thing that investors need to contend with. The Spanish bond market is pricing in the risk of the government needing to bail out its banking sector, hence why its bond yields are flying higher this morning. The 10-year yield has risen nearly 25 basis points so far today and is back above 6%. Yesterday we noted how calm the European sovereign bond market seemed compared to equities and the FX market. So is the bond market now playing catch-up? Usually the bond market directs other asset classes, so if the increase in Spanish bond yields continues at this pace then this could be the trigger event that could cause EURUSD to convincingly break below 1.30 and for equities to fall below recent support levels.
The chance of this happening depends on how markets react to the latest banking plan from the Spanish. This is expected to be released on Friday, and could include an enhanced re-capitalisation programme larger than the EU 50bn the Spanish government announced last year. Back then it suggested banks could raise some of their fresh capital needs via the capital markets; however with the Spanish stock market back at 2009 lows it is hard to see where the demand for a slice of the Spanish banking sector is going to come from. This leaves it up to the government or an EU entity to stump up the cash. If the government intervenes it would threaten the stability of the public finances (which are already fairly fragile) and could push Spain into requiring a bailout. Thus, it may be that the EU puts together some banking sector bailout, and creates a bad bank for Spanish assets. We will learn more on Friday.
A critical month for the future of the Eurozone
Either way we think that the next month is critical for the future of the Eurozone, and the uncertainty it causes could weigh on risk assets and the euro. In the next four weeks we should know who is controlling Greece, whether or not it runs out of money or chooses to adhere to its bailout terms and how the Spanish government plans to sort out its banking sector. There are high levels of market risk associated with all of these events, which we believe is euro negative. However, because the euro has traded in such a tight range since the start of this year, we do not expect to see a sharp dive lower for this pair - rather we think it will move lower in incremental steps. A close below 1.2950 in the next day or so is negative for this pair and opens the way to 1.2935 then to 1.2900. Below 1.30 the ultimate support is the 1.2670 lows from January 16th this year. So, the break below 1.30 since the Greek and French elections is a significant event for us and may be a watershed moment for EURUSD.
We have spoken above about EURUSD, but the euro is also weak versus the pound. We prefer to trade pound strength versus the euro rather than the dollar, as the greenback could bounce on safe haven flows. EURGBP is heading towards 0.80 right now, which is likely to be a key area of support. We prefer to sell on strength - potentially any bounce towards 0.8090 may be a good selling point in our view. Tomorrow the BOE announces its latest rate decision. We don't expect any change, although the negative Q1 GDP reading means that there is some expectation in the market that the BOE could increase its stimulus programme tomorrow. If the Bank remains on hold then the pound may bounce back towards 1.6220 resistance as this may be perceived as a hawkish move by the BOE. It could also push EURGBP below 0.80.
The other big mover of note is the Aussie. AUDUSD has fallen sharply since yesterday's Budget that opened the way for further RBA cuts. 1.0050 attracted some corporate buying demand this morning so that is now a key support zone on the way to parity. But we do expect as move towards parity in the short-term, especially if risk sentiment continues to turn negative.
One to Watch: SPX and commodities
Commodities have been hit hard in recent weeks and the asset class has suffered more than the SPX 500. The Thomson/ Jefferies Commodities index is down nearly 10% since March compared with a 4% decline in the SPX 500. Commodities have been hurt in recent days by the decline below $1,600 in gold and also the fall below $100 per barrel in WTI. Commodities and the SPX tend to move closely together as you can see in the chart below. Thus the sharp decline in commodities could be followed by equities with a bit of a lag. A break below 1,350 in the SPX 500 opens the way to key support just below 1,300 - the 32% Fib retracement of the Sept 2011 to March 2012 uptrend, and also the 200-day sma.
CRY and SPX 500
Source: Bloomberg/ Forex.com
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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