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After rumours that the independent audit of Spain's banks would be delayed until September the Spanish authorities have decided to announce the preliminary results from the audit at 1630BST/ 1130 ET today. The full audit will be carried out by the Big 4 firms, so this preliminary audit is presumably being carried out by the smaller two firms, out there?

The markets expect that the results will find a capital shortfall of EU 60-70BN. This figure is less than the EU 100bn bank bailout, which is crucial for the audit results to have a positive impact on market sentiment. Anything larger than EU 100bn may cause another bout of market panic, causing Spanish and Italian bond yields to surge and risk assets to tumble.

Risk sentiment has drained from the market throughout the London Session. After a fairly inconclusive reaction to the FOMC, sentiment has been dented this afternoon by a raft of weak economic data from the US. The Philadelphia Fed dropped to its lowest level since September last year, after the markets had expected a bit of a recovery. Likewise, confidence data and existing home sales data were also weaker. This should come as no surprise to the Fed, Ben Bernanke called the US housing market depressed during his testimony to Congress earlier this month, and the Spanish bank bailout along with Greek election concerns were probably enough to weigh on US confidence this month. Hence, the weakness in the data is unlikely to change the Fed's mind, and we doubt that Bernanke is wishing he had taken bolder action right now.

But even though the economic data is unlikely to cause the Fed to spring to action, it has had a big impact on the Treasury and FX markets. The 2-year US bond yield had moved above 0.3% yesterday post the FOMC announcement, after falling for a month. However, it has reversed course today and the yield is back at 0.2985%. This is problematic for USDJPY, since the two tend to move together. Although USDJPY is back above 80.00, it is getting caught in the 0.8015-20 resistance zone. While we expect the market to be sensitive to US economic data misses, especially since the Fed said that more accommodation could be applied if it was necessary, we still think the Fed is the least likely of the major central banks to pull the trigger on more QE (the BOE, BOJ and even the ECB is ahead of them, in our view), which is broadly dollar positive in the medium-term.

Although EURUSD failed to fall through the floor as some had expected if the Fed didn't do more QE last night, it has not managed to stay above 1.27 today. After hovering around 1.2650 we have seen a sharp decline on the back of the weaker economic data from the US and as the market gets ready for the preliminary results of the Spanish bank audit. 1.26 is holding as support for now, but if the dollar index can scrape above 82.05 then there could be further declines in store for EURUSD. Below 1.2580 opens the way to 1.2520 - the 21-day moving average and a key level a lot of people in the market will be looking at. Overall, we think the euro will consolidate as we lead up to next week's EU summit. Since the summit could be a major game changer for the currency bloc, we don't think the market will have much of a directional bias in the coming days, so we could be range-bound between 1.2450 - 1.2730/50 (a short-term top that was formed on Sunday).

It's been easy to forget that Greece has a new pro-bailout government in place, especially as the focus remains firmly on Spain. We can't forget Italy either as the results of Spanish stress tests could impact Italian bond yields. Essentially if they boost sentiment towards Spain and make the country appear more credit worthy (I use the term loosely) then we could see Italian yields extend their recent declines back towards a more normal 5.5% in the 10-year bond. However, any adverse surprises may cause it to rise above 6%, fuelling major risk aversion across euro-based asset markets.

The risk-off tone to the markets has hurt sentiment towards oil. In fairness the oil price was at risk of a sell-off after a slew of weak PMI data from China and Germany was released earlier this morning. An attempt at a rally back towards $92.50 was thwarted by the weak Phili Fed. Below $91.50 opens the way to a test of $90, a critical support zone. Gold is also looking vulnerable as it tests support at $1,585 (below the base of the Ichimoku cloud) yet again. It suggests the bears are building momentum and we could be in store for a move back towards $1,550 in the yellow metal. Stocks in Europe are fairly resilient, while stocks in the US are lower. The near-term direction of stocks and risky FX will depend on the outcome of the bank audit in Madrid, so watch out for volatility at 1130ET/ 1630 BST.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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