Eurozone event risk has been front and centre today. Firstly Germany's top court gave the green light to a longer-term bailout fund for the currency bloc; there was also a State of the Union address by the EU Commission President. By far the most important event for the markets was the German court ruling. But what does it actually mean for risky assets?
The court ruled that Germany's political leaders could sign up to the treaty that will establish the European Stability Mechanism (ESM), a EU500bn bailout fund. But this came with conditions: it ruled that there needs to be a EU190bn ceiling for Germany's contribution to the fund to ensure that Berlin does not get lumbered with unlimited liability to try and bail out Europe's financially troubled states.
So how is this impacting the markets? This ruling was eagerly anticipated but some thought that the conditions might be extremely onerous. Even though the justices ruled that Germany's contribution must only be EU190bn (hardly enough to bailout Spain let alone Italy), it left the door open to a larger contribution by saying that the lower parliament would have to vote on any increase in its size. So, as long as there is the will within Germany's political classes to save the Eurozone then there is the cash. This is a mini victory for Merkel and co. after the court ruled against the challenge to the ESM posed by 37,000 German citizens from the More Democracy movement, who wanted to stop the state president Joachim Gauck from signing the ESM and the accompanying fiscal compact into law.
This news is euro positive. It breathes life into the ESM as without Germany's support there can be no bailout fund. It is also good news for Spain and its 10-year bond yield dropped 10 basis points on the news, which is now back at 5.6%. This also helped boost stocks and the euro. EURUSD is now above 1.29. 1.2935 is a key resistance level and above here 1.3005 comes into play. As we have said in the past, when you get close to psychological levels like 1.30 in EURUSD the market tends to do one of three things: 1, cruise through it as the bulls take full control, 2, hover around the level for a while as investors decide what to do next and some people take profit or 3, back off this level as investors believe this is high enough, thus implementing a temporary top in the process. The next 24-48 hours for EURUSD will be pivotal to whether we get above 1.30 and stay there. Although the political situation in Europe is euro positive (bar the outcome of the Dutch election, which should see the pro-euro Liberals win enough seats to be the majority partner in a coalition) the FOMC meeting tomorrow is a major unknown.
Look out for our FOMC Research Note produced later today. I would note that in 2010 the markets bought the rumour and sold the fact- the dollar fell sharply prior to the announcement of QE2 before rallying over the NEXT 4 weeks directly after the announcement and then selling off again from January 2011- June 2011. Thus, the FOMC will need to do something that shocked the market (like unlimited bond purchases) to extend this rally in risky assets, and we would expect some volatility in EURUSD in the near-term.
But nothing is ever simple in the markets when central banks are determining price action, so also keep an eye out for an announcement from Spain that it is applying for a formal sovereign bailout, which would trigger the ECB's bond buying OMT programme. Spanish PM Rajoy hinted today that he may be more malleable to the idea of applying for bailout funds. This could limit euro downside in the event of a 1, a post FOMC sell off and 2, an application from Spain for a bailout in the coming days.
One to watch: EURUSD daily.
This pair has obliterated its 200-day sma at 1.2830. This is a significant break to the upside. However, the daily MACD as you can see in the chart below is looking particularly overbought, so we may experience some stickiness as we move towards 1.30. In particular there is a risk of a euro sell off on the back of tomorrow's FOMC meeting, so watch out for some volatility. See above for more detail on the euro and Eurozone situation.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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