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What a difference a couple of hours make. It looked like the euro might be in the doldrums and then it shot through 1.3400 and key resistance at 1.3415. Added to this Italian bond yields dropped 10 basis points at one stage even though Rome had to pay 7.89% - the highest level since 1996 - to sell EUR3.5bn of 3-year debt.

So what were the markets so excited about? Perhaps it was the fact that the auction in Rome was well received with a healthy number of bids, so the auction could have been much worse. It could also be reports from the Bank of Italy yesterday that Italian debt levels can still shrink with yields above 7%. So that's it: the markets have become immune to Italy paying high yields to borrow money and for now it is sustainable, but going forward it won't be. Italy is forecast to barely stay out of recession next year with the EU Commission predicting growth of just 0.1%.

However, that isn't on the market's radar right now and stocks and risky FX are moving like the world is a happy place and the sovereign debt crisis doesn't exist. But every so often the glee is interrupted by a negative headline. For example, EURUSD fell back below 1.34 on the news that Finland's anti-Europe opposition party had called for a no confidence vote in the government. This tiny party has been a big voice in Finland against further European integration and if there was a way out of the Eurozone you could see Finland rush to the exit before Greece. This has caused a disruption to risk appetite; although this may prove to be temporary it highlights the fragile nature of this risk rally.

But although problems remain the European bond market is telling us that the debt crisis has moved to a new phase. As Italian yields have moderated German yields have risen. As we said yesterday, the solution to the Eurozone crisis is a zero-sum game and if there are winners (weaker sovereigns see debt costs fall) then there must be losers (stronger sovereigns will see debt costs rise). Thus it is no surprise that as Eurozone finance ministers gather in Brussels the Italian yield curve is returning to some kind of normalcy, with the spread between longer and shorter-term debt starting to narrow and post the debt auction the yield curve is back in positive territory.

This tells us that even the wise old credit market is expecting the situation in Europe to be sorted out in the near-term; however we doubt much will come out of the Eurozone finance ministers' meeting today in Brussels and we could end up second guessing the outcome of the EU leaders meeting for the next week or so. Some details have been leaked, for example there is some disagreement over how banks are re-capitalised with some calling for national efforts (Germany) and some calling for a multilateral approach (France). This bickering needs to be sorted out since Europe's banks are on their knees, if this sector is left to flounder then stocks are vulnerable to further declines.

Either way, Europe is still the focus today and risk can't keep this rally up if there isn't dramatic action in the coming weeks: including Treaty changes, concrete plans to leverage the EFSF that could sway China to get involved, right now it doesn't seem that interested and at least an expanded role for the ECB. We think that Eurobonds are unrealistic at this stage and are not necessary to stabilise the situation. They are for some time in 2012 once the Treaty changes are enacted.

Everyone seemed to think that credit rating agencies were done for after the securitised mortgage mess back in 2008, but they have been pivotal to investor sentiment during the sovereign debt crisis. The rating agencies are quietly not tolerating political bickering and stasis when it comes to fiscal consolidation. Hence the fact that the US, Japan and France may see credit rating downgrades over the next few months and years. Standard and Poor's said that it could cut France's credit rating in the next 10 days, according to reports in the French press. The report also said that France was due to be downgraded with Belgium on Friday but it was postponed - a phone call from the Elyse Palace perhaps?? If France is downgraded in the next few days then it couldn't come at the worse time. Firstly, EFSF bond yields have been rising recently and rely on France to keep its top credit rating so that it remains triple A. Secondly; it makes Sarkozy's re-election less likely next year and increases political risk in the currency bloc.

The US was also put on negative watch by Fitch last night so the world's biggest economies are getting targeted by the credit rating agencies right now and to say that their influence has waned is incorrect.

The UK is gearing up for the Chancellor's statement at 1230GMT, however although Osborne is likely to deliver a less than optimistic message this hasn't stopped the pound. Sterling is on a roll: GBPUSD is testing 1.5650 and EURGBP is testing support at 0.8550. We have seen the pound shrug off domestic bad news. Today the Bank of England announced that lending had shrunk in October relative to September and that annual money supply growth fell by the most since records began, but the pound didn't flinch. We think it could be benefitting from the influx into Gilts, which have benefitted from the Eurozone debt crisis and acted like a safe haven.

More from the autumn statement later.

Data Watch:
12.30GMT/ 0630 ET UK Osborne makes Autumn statement to the House of Commons
12.30 GMT/ 0630 ET EU Stark speaking
12.30GMT/ 0630 ET UK OBR publishes Economic and fiscal forecasts
13.30GMT/ 0730 ET CD Canadian Current acc Last -15.3 bio Exp -11.1 Bio
14.00GMT/ 0900 ET US Case Shiller House price index Last -0.05 M/M -3.8 Y/Y Exp -0.1M/M -3.0 Y/Y
15.00GMT/ 1000 ET US Consumer Confidence Last 39.8 Exp 44
16.00GMT/ 1100 ET EU Euro group commences.
16.30GMT/ 1130 ET US Yellen speaking
17.30GMT/ 1230 ET US Lockhart Speaking
00.30GMT/ 1930 ET CD BOC Deputy Governor Murray speaking
01.00GMT/ 2000 ET US Kocherlakota speaking

Best Regards,
Kathleen Brooks| Research Director UK EMEA |
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