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After staging a fairly impressive rally on the back of the EU finance ministers' meeting yesterday and news they had come up with a blueprint for Spain's bailout fund, a couple of things rocked the markets today. The first was news from the German Constitutional Court that it may take up to three months to approve the ESM, the long term rescue fund, which was expected to come into force on July 1st. This is important since the main breakthrough at last week's EU summit was that rescue funds could potentially become more flexible in the future, which is vital for debt-laden countries like Italy that have not yet had to accept a bailout. The second thing weighing on the market seems like comic timing: Italy's PM came out earlier and said that Rome may tap the ESM for money if it could. So there you have it: Germany once again thwarting the attempts of the southern periphery to get bailout money on the cheap.
The markets didn't seem to like the lack of clarity on what the ESM will look like and hence the euro fell back through 1.2280 and to fresh lows just above 1.2230. On an intra-day basis the markets are extremely jittery and are willing to react negatively to any sign that the European authorities are unwilling to work together (and at a fast pace) to save the Eurozone. This leaves the euro at risk of one step forward, two steps back, at least in the short-term. However, the medium-term picture is no less bleak. The euro is likely to be hobbled by the economic and political situation in the Eurozone, and below 1.22 there isn't much support between now and sub- 1.20. Whether or not we get below here depends on the outlook for the US, if the economy continues to show signs of weakness that could cap dollar gains and thwart efforts of the euro bears to push the cross below the June 2010 low.
European stocks are poised to close higher today, although they gave back a lot of their gains as we led up to the open and heard from the German court. Interestingly, the Bloomberg European financial index seems to have bounced off support today and is still within an upward channel. This is important, as banks in Europe need to recover for the wider stock market to make sustainable gains in our view. Perhaps stocks in Europe were so cheap it attracted some bargain hunters? This is one of our 3Q views that European stocks may outperform their US counterparts as the markets adjust to a lower growth environment in the US.
EURAUD also broke through some recent lows to make a fresh euro-era low below 1.20. We expect this pair to meander down towards 1.15 this quarter as interest rate differentials work in the Aussie's favour.
That reminds me, our Q3 outlook is released tomorrow with all of our views for the quarter and FX currency ranges. Be sure to check it out. Also, watch out for the Fed's minutes tomorrow evening UK time, as the market looks for signs of easing. Will risk asset rally if QE3 is waiting in the wings? Or will the Fed say they are out of bullets with Treasury yields this low? We shall have to wait and see.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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