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Spain has been in focus this week; its budget for 2013 was released yesterday while we are waiting for the results of independent stress tests on its banking sector that are scheduled for release at 1700 BST/ 1200 ET today after European markets close. We don’t expect these results to be too shocking. We already know that Spain’s banks are under-capitalised and nearly drowning in bad loans (the bad loan rate is nearly 10%) so we are looking at the extent of re-capitalisation that the independent auditors report. The market expects somewhere in the region of EU60bn, which is well within the EU100bn ear-marked for Spain’s banks from the EFSF rescue fund. We don’t expect a bigger number than EU60BN, but obviously if the number is larger then the euro could come under pressure in the second half of the US session.

Unrealistic targets

The fall-out from Spain’s Budget has been fairly minimal. The chief cause for concern for traders is that next year’s deficit target of 4.5% looks unrealistic and the growth forecast of -0.5% for 2013 looks optimistic at best. This may be why although we have seen the euro rally on the back of the Budget announcement it has been more of a whimper than a roar and EURUSD doesn’t seem to like the air above 1.2950. Thus a close above 1.30 this week seems unlikely at this stage. The lack of follow through in risk assets after the announcement of the Budget suggests to me that any rally post a Spanish bailout request could be short-lived and euro upside may be capped at 1.33 for the next few months.

To request a bailout, or not to request a bailout …

The Budget does not immediately herald a bailout or aid request from Spain, and so we end the month without the activation of the OMT programme. It will be interesting to hear what Mario Draghi says at his press conference next week after the October ECB meeting about the delay. The Economy minister said yesterday that Spain’s economic reform plan “exceeds the recommendations of the EU”; however it seems that a decision on a bailout request has not been made. A Spanish official said Madrid had to be aware exactly what a bailout would mean, while an EU official said they needed time to digest the Spanish Budget, but that Spain is moving in the right direction and its reform plan “exceeded recommendations in certain areas”. Still no formal bailout request. What the Budget did was lay out the huge scale of economic readjustment Spain needs and the market may start wondering how that will be achieved even if the OMT programme is activated.

France also has to make a huge economic adjustment. It announced its 2013 budget today and it was even less radical than Spain’s. Rather than try to reform the public sector, France decided to freeze public spending instead. It also predicted that the budget deficit would be brought down to 3% of GDP next year, from 4.5% this year, which could be a tough call if spending is not falling. The 0.8% growth target even looks optimistic as the economic data continues to deteriorate and unemployment is on the rise. The bulk of savings next year will come from tax increases, including a temporary 75% tax on top earners. This has invoked the ire of the French business community and UK PM David Cameron may be getting ready to “lay out the red carpet” for the expected exodus of French business people who may flock to London to get slightly less erroneous tax rates. The budget hasn’t damaged French bonds, as yields continued to fall to below 2.2% today. France may still be acting like a safe haven, but its public finances remain on a very precarious path.

Sovereign ratings risk comes back into focus

Watch out for Moody’s who is expected to deliver its review of Spain’s sovereign credit rating today. Another downgrade could cause Spain to fall into junk territory. It will be interesting to know how Moody’s views the OMT programme and if it will give Madrid the benefit of the doubt that the ECB does stand behind its bond market even if it is still not activated. Moody’s could deliver its review after the NYC close tonight.

Watch rising inflation in Europe

Economic data has also been in focus today. The Eurozone’s flash estimate of CPI for September unexpectedly rose to 2.7%; the expectation was for a fall to 2.4%. This could ignite the fire of the Bundesbank who are particularly hawkish, but the market didn’t seem to pay too much attention. It may mean an interest rate cut is unlikely any time soon, but the OMT programme has already been announced seemingly without consideration for rising inflation. But if prices continue to rise then we may see more caution around bond purchases if the OMT is ever triggered.

Elsewhere, US economic data is also in focus today. Personal income and personal spending were released and came in roughly in line with expectation, although income was 0.1%, below the 0.2% expected. The PCE core deflator, an inflation rate looked at by the Fed, was 1.6%, which supports QE3 as this is below the Fed’s 2% target rate. Look out for confidence data due out at 1455 BST/ 0955 ET later today.

One to watch: AUDJPY

This is the ultimate risk trade, as you are trading a high beta currency (AUD) against a safe haven (JPY). Thus, it tends to be very sensitive to change in risk sentiment. After a stunning rally post the ECB meeting, it has started to fall through some significant levels, which could be a signal that wider market sentiment is starting to deteriorate. The decline through 81.15 is worrying for the bulls as this is the base of the Ichimoku cloud, and is thus the start of a technical downtrend for this pair. Below 80.80 to 80.40 in the short term and then 79.90 – the double bottom from earlier this month – come back into view. It’s worth watching this pair as it may signal wider declines in risky FX like EURUSD, GBPUSD etc., and increased demand for safe havens.

AUDJPY: daily Ichimoku cloud chart


Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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