The euphoria that gripped markets yesterday has continued today as expectations continue to build that Europe's leaders will bring the sovereign debt crisis to a neat solution.

Themes:

· There was a huge amount for investors to digest yesterday: 1, the prospect of a resolution to the sovereign debt crisis through an extension of the EFSF's size and financial firepower, 2, the ECB potentially re-starting its 12 month loan facilities for troubled banks and the extension of covered bond purchases and 3, growing expectation that the ECB may cut rates as early as next month. Speculation on how Europe can stem the crisis is dominating the headlines.

· But investors shouldn't be too quick to expect a rate cut from the ECB. Finnish member Liikanen sounded more hawkish than some of his colleagues in a speech earlier when he said that monetary policy must ensure inflation eases in 2012. So there is still a hawkish element at the ECB and future policy decisions are still up for debate.

· But what could spoil the markets' party? There is still plenty of risk out there that could trip up markets. Firstly, a EUR2/3 trillion plan to stem the sovereign debt crisis and save the Eurozone is fantastic in theory, but in reality might never see the light of day. The markets have ignored comments from Finland that it would not support any extension to the EFSF - this is significant since it is one of only six Eurozone members with a triple A credit rating. Added to this, Greece and Germany are scheduled to hold a teleconference this afternoon. Greece needs to reach its fiscal targets to continue to receive bailout funds. It may have secured its 6th tranche, but the 7th tranche is due in December so time is running out to implement budget cuts. Also there is an ecofin meeting next week and one in mid-October where the international community expect the new plan to save the Eurozone to be presented. So there is 3 weeks for the EU to come up with a plan that 17 members will agree on... (This may be a tad optimistic).

· Italy and Spain hold debt auctions today. Italy aims to sell EUR3.5bn in 2013 bills; Spain is selling 77 and 175 day bills at 0930 BST. The ECB may well have to buy the debt in the secondary market to ensure the auctions go according to plan. Also, Europe's third and fourth largest economies still have to issue short-term debt as longer-term investors remain elusive.

· We can't forget that the US still has its own problems. The Senate just about reached a spending deal last night that would avoid a government shut-down at the end of the month. The US continues to live hand-to-mouth, which is not dissimilar to Greece, Portugal etc.

· The US economic outlook may also start to weigh on the markets. New home sales for August registered a fourth straight decline it was reported yesterday. Today S&P/ CS house price data is expected to show an annual decline of 4.4% in home prices in the 20 largest cities in the US.

Markets:

· Stocks continue to move higher today after yesterday's rally.

· The dollar had a weak Asia session, but has found its feet early in the European session; this is capping EURUSD at 1.3560 so far. So we may see risk start to fade later on. We need to get above 1.3660 for this rally to be sustainable.

· EURJPY has also run into some resistance at 103.60.

· Rumours of a large quarter-end fix in EURGBP could weigh on the cross this week. Support lies at 0.8640 then at 0.8585.

· Stocks have had another positive start, but prices remain in no-man's land. We need to get above 5,295 in FTSE 100 - 38.2% retracement of July - Sept decline- for us to have turned a corner.

· We don't think this is sustained rally, and if the euro loses steam later today it may signal a pull-back in risk. Expect volatility.

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Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

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