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Risky assets including the euro have started the week on a positive note today and rallied at the European open. There hasn’t been a concrete catalyst as there have been no economic data releases of note during the European session. It seems like FX and stock markets are taking their cue from the bond markets as Portuguese 10-year yields fell to their lowest level since March 2011 at 8.01%. The rally in Portuguese sovereign bond markets comes just ahead of its 2013 Budget, which is presented later today. Lisbon is expected to announce measures to plug its budget deficit next year. A transaction tax and a hike in income tax are some of the changes expected. However, in an environment of weak growth and rising unemployment, which is at a record high of 15%, the budget gap is unlikely to be plugged by hiking taxes alone, thus more spending cuts are also expected to be announced. This could cause social unrest and mass protests are planned for today.

Austerity – a dirty word in Lisbon

Austerity is a dirty word in Europe at the moment, so why is the sovereign bond market rallying when Lisbon’s budget could make the growth outlook even worse? In the immediate term, the market may be expecting an EU/ German-friendly budget from Portugal that could ensure Portugal remains on side with its paymaster. Also, the ECB’s OMT programme has helped benefit Portuguese yields. The EU summit on Thursday and Friday of this week is boosting expectations that Spain may apply for financial assistance and thus trigger the ECB’s bond buying programme. It is still a little murky what Spain actually needs to sign up for: does it need to request a conditional line of credit or actual funds? Does it just need to sign up for another round of austerity or does it need to cede budget sovereignty so that Brussels is put in charge of implementing its austerity plans for next year? These are all unanswered questions at this stage, but the markets are hanging onto the hope that the OMT could be triggered later this week or next after Sunday’s regional elections in Galicia and the Basque country that take place on Sunday. There has been a lot of unrest in Spain’s autonomous regions including anti-government and austerity protests, so the government may not be willing to sign up for more austerity prior to these important elections.

The EU summit is the most important event in Europe this week as investors wait for the OMT to be triggered. If this does not happen then expect markets to be disappointed and risk assets may sell-off. Spain’s government may not be that keen on signing up to a programme as its bond yields remain well below the 7% mark so it may not decide that an aid request is a priority. If this happens then the OMT may start to lose credibility as investors start to doubt the ECB’s position as the effective lender of last resort to the troubled Eurozone members. So it might be worth getting your tin hat at the ready.

Gold loses its lustre as Chinese inflation continues to fall

The EU summit may provide some opportunities later this week. Ahead today US retail sales could cause a ripple of excitement, although an increase in sales (0.8% is expected) could be down to rising gasoline prices, and may not be as “good” as the headline number suggests. Elsewhere, the weaker Chinese inflation data, it fell to 1.9% last month, has boosted stimulus expectations and had a positive impact on the Aussie.  AUDUSD recovered from 1.02 (now looking like a short term double bottom) earlier, but is hitting short term resistance at 1.0240. EURUSD is still going strong, and the next level to watch is 1.2990 – above here opens the way for another test above 1.30, 1.3020 is the next key resistance level to watch, although we don’t see a particularly bullish or bearish bias emerging until after the EU summit at the end of this week. Gold continues to get sold off as investors remain wary of the impact of QE3 from the Fed and also the prospect that the ECB’s OMT programme will end up being a lame duck. The decline in Chinese CPI to 1.9% has reduced the prospect of inflationary pressures weighing on the global economy, eroding the need for an inflation hedge like gold. $1,740 is acting as fairly good support for now, below there opens the way to $1,710 in the short term. Resistance lies at $1,765.

Gold: hourly chart



Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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