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We mentioned yesterday that now that Greece has its bailout money and Spain is fully funded for this year the focus could shift to the US and the fiscal cliff. Indeed it did. After some positive comments in recent weeks that Republicans and Democrats may compromise and reach a deal in good time, we received some negative headlines from Capitol Hill yesterday. US Senate Leader Harry Reid, a Democrat, said that little progress has been made on reaching a deal. This triggered a sell off in NYC hours, which, in the absence of other market drivers, continues to sour sentiment during the London session.

Headline risk ramps up

In truth, a deep market sell-off could push both sides to reach a compromise sooner rather than later. We have a little over a month before the US goes over the cliff edge, so expect headline risk to ramp up over the coming weeks. The markets are focused on the US fiscal negotiations and are even dismissing some impressive data from the US economy. Durable goods orders combined with better housing market data, which suggest this important sector of the economy is picking up speed. But the market is worried that bickering on Capitol Hill could render the pick-up in economic data meaningless and sharp tax rises and spending cuts in one go could leave the US economy mired in recession next year. Hence the market’s ability, at the moment, to turn a blind eye to good economic data. However, if a deal is reached, combined with signs of an economic pick-up in the US and Chinese economies then we may have the foundations for a strong rally in risky assets.

ECB and Madrid play their own Game of Thrones

The markets are fairly tricky to trade at the moment. There has been a dearth of top tier data in the European session, and all eyes are now focused on next week’s ECB meeting. Earlier today the Bank of Spain said there were some signs that the impact of steps taken by the ECB were starting to fade.  There is an interesting game of brinkmanship going on between Spain and the ECB, with both sides egging the other on to make the first move. We tend to think that Spain will still need to make a formal aid request before the ECB activates the OMT. Although it is unlikely to do this year (it is fully funded for 2012), it has a hefty debt issuance schedule for 2013, which we think may cause Madrid to topple.

EURUSD – approaching key support zone

Needless to say, the current macro environment including fiscal cliff negotiations and OMT stasis is keeping markets fairly range-bound. EURUSD continues to sell off today and is testing 1.2900 support. There is a cluster of support below here at 1.2880 then at 1.2850, which could protect the downside and attract some buying interest in the absence of negative headlines. We believe that there is resting interest in the euro and it could recover later this week/ early next week. Spanish and Italian bond yields are calm and Italian 10-year yields fell to their lowest level since June 2011 earlier today. Reduced credit risk in these countries tends to help the euro to rally, thus we could see a re-test of 1.30 in the medium-term.  Whether or not we get above here depends on macro events and the outcome of the fiscal cliff negotiation in particular. If we get a neat resolution then we could see the bulls take charge into year-end, which may help EURUSD get above the top of the daily Ichimoku cloud at 1.2995.

Gold – losing its lustre

The other asset class we think is worth watching is gold. It is trading sideways at the moment and has been caught in a tough resistance zone at $1,742, the top of the daily Ichimoku cloud. This is a pivotal resistance zone for this cross; if it fails at this level then we could see back to $1,700 then $1,680 in the medium-term.  Even if fiscal negotiations are resolved we see gold gains capped, since a positive resolution to the fiscal cliff negates the need for QE3, which had helped gold to rally since the summer.  In the short term I see gold trading between $1,710 and $1,750. If you like trading gold then narrow your time frames and keep an eye on these support and resistance levels.

Ones to Watch:

1, EURUSD daily Ichimoku cloud


2, Gold: Daily Ichimoku cloud


Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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