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The markets are in recovery mode after yesterday's rout in bond, stock and FX markets. Spanish bond yields have fallen 14 basis points after reaching fresh euro-era highs yesterday, and even Germany has seen the relentless buying of its bonds ease off a bit today. Yesterday the yield on 2-year German government debt fell to 0%, it has recovered to 0.025% today, but another bout of market panic and investors may start paying Germany to look after its money. The bond markets led the market lower yesterday, today they point to a continued recovery as the bears take a breather.

Some rare good news for Europe


Interestingly today, there has been some good news for Europe, which has helped to spur the recovery in sentiment. The German unemployment rate fell to 6.7% from 6.8% in March, and inflation in the currency bloc also fell to 2.4% from 2.6% in April. This gives the ECB room to potentially add more stimulus to the economy, although don't hold your breath. ECB President Draghi was speaking in Brussels at the European Systemic Risk Board this morning. He said that the Bank would continue to lend to solvent banks, but he seemed to rule out further action by saying that markets were not in as much stress as they were in November. I agree with him to an extent, interbank lending rates for the Eurozone are lower than they were in November when they spiked to their highest level since the financial crisis in 2008. Added to that France, Belgium, Austria etc have not seen their bond yields spike, suggesting that Spain and Italy have broken away from the core European pack. Back in November French bond yields also started to rise, adding to the overall sense of market panic.

Draghi to governments: act now


That does not mean that Draghi was complacent. He highlighted the graveness of the crisis and put the onus on leaders to clarify their position on the euro and take action to stem the crisis. He suggested that an EU wide bank deposit insurance scheme should be adopted to prevent capital outflow from the weakest states in the currency bloc and to prevent bank runs. The next EU summit takes place at the end of June, so the focus shifts to that. However, after yesterday's rout in the markets we may need to see the crisis deteriorate even more for the EU to act.

Even troubled Spanish lender Bankia is recovering today along with the rest of the European banking sector. It was soothed by Draghi's words, although he didn't address the request by the Spanish PM for the ECB to revive its bond-buying programme.

Athens vote could be tight


One of the final pre-election polls from Athens came out today and put the pro-bailout party New Democracy in the lead. However, the far left anti-austerity party Syrizia is not that far behind, so the election on 17th June is likely to be a close call and could end up with another fraught coalition and the bailout terms being re-negotiated anyway. The next few months will be of huge historical relevance for the currency bloc - how to marry the Greeks wish to stay in the currency bloc with their wish not to have to deal with further austerity...

So the markets may be stabilising but an uncertain future for Greece combined with no policy action to put this crisis to bed once and for all is enough to keep markets on high alert. Headline risk is still a major concern and could cause the euro to decline and Treasury yields to fall even further.


Market moves:


We are seeing a broad based recovery today. The dollar is lower and EURUSD has been steadily climbing above 1.24. We have heard there are some corporate offers around 1.2440/50, which may stem the rally. The euro short trade remains crowded, so pullbacks are natural. However, the fundamental picture remains bleak so it's hard to see a sustainable recovery in the single currency on the cards. 1.2360 remains support ahead of 1.2150 and then the 1.20 level.

The markets are in usual recovery mode, the euro, stocks, the Aussie and the pound are higher while the dollar and the yen are lower. After falling to 78.70, USDJPY has stabilised just above this level. Although the market is right to be concerned about intervention risk form the Japanese authorities, it's hard to see anyone successfully standing in the way of the yen when risk aversion takes hold, so USDJPY could continue to grind lower.

In EURJPY, 97.05 - the low from January - is the support level to watch. Gold managed to hold support at $1,530 - the 100-week moving average - and is moving higher along with the rest of the commodity space so far today.

So how long can the recovery last? This is the million dollar question. Longer term charts for the yen crosses look overbought, while the weekly gold chart looks deeply oversold. In the short term the MACD and RSI indicators are starting to move into overbought territory in after the strong pullback since the European open.

But on pure technical indicators the pullback in risk could be protracted due to the extent of the sell-off in assets like the euro, Aussie and GBP over the past month. However, headline risk remains a major concern and the European crisis has brushed aside technical indicators in the past.

Ahead today US labour market data comes into focus with the ADP private sector payrolls data and initial jobless claims. Weak data could boost the chances of more QE from the Fed, which could help a rally in risk and weaken the dollar. The Irish referendum could also gain some airplay. The people are expected to vote yes to the Fiscal Treaty; however it could be a close call so watch out for headlines from Dublin.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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