Risk assets pull back as caution prevails

Risk assets faltered especially in Europe in the wake of renewed political tensions in Italy and Spain. Election uncertainty in the former as former Prime Minister Berlusconi gathers growing support and government corruption allegations in the latter hit equity markets and peripheral bonds.

Consequently the EUR gave back some of its recent gains, with the currency not helped by comments by the French finance minister warning about its strength. EUR/USD downside will be limited to support around 1.3461 in the near term.

Weaker Spanish jobs data did little to help sentiment while service sector confidence indices in the Eurozone today will also provoke further concerns revealing both continued contraction for most countries and divergence in the bigger economies, namely Germany and France. Caution will prevail in the near term as markets begin to question the veracity of the rally in risk assets registered over recent weeks.

AUD has had a fairly erratic start to the year rallying to break 1.06 against the USD but failing to hold gains over recent weeks. The currency has looked a little more stable into February but is still showing little sign of rallying despite the recently firmer risk tone, weaker USD index and firmer Chinese data, all of which would have been supportive for AUD in the past.

Technically AUD/USD looks vulnerable according to the relative strength index (RSI). Moreover, speculative positioning is around the 3 month average suggesting little impetus either way.

The RBA decision today to hold the cash rate unchanged but keep open the door to further rate cuts will inflict more short term pain on AUD but given that the market had already priced in a further rate cut in the cycle any decline in AUD will be limited. A break below the 100 day moving average around 1.0415 will result in a test of support around 1.0381.

Although the AUD is faltering its drop pales into insignificance compared to the sharp decline in JPY over recent weeks. Obviously the drop in the JPY has caused some panic across other currencies, especially in Asia (KRW, TWD, MYR), but this has done little to sway JPY bears. I have some hesitancy in calling the JPY much lower especially as a lot appear to be is in the price (in terms of aggressive policy actions) but technical indicators for both USD/JPY and EUR/JPY remain bullish despite the pull back overnight.

The intensifying hunt for yield means that the JPY will remain on the back foot over coming months but in the short term JPY may find some support from a renewed rise in risk aversion as political tensions in Europe heat up as well as some caution that the risk rally looks overdone. However, speculative positioning is unlikely to get in the way of further JPY declines given that positioning is around the 3-month average and still well above the all time lows reached in June 2007.

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