Beware of EUR short covering

Europe has plenty of events to focus on over the next couple of days including the European Central Bank (ECB) Council meeting, and debt auctions in Spain and Italy. While I am by no means a EUR bull the risk is skewed towards some short term recovery or at least stabilization around EUR/USD 1.28. The speculative market is extremely short EUR while policy makers, specifically German Chancellor Merkel and French President Sarkozy are making the right noises. it appears to have finally dawned on Eurozone officials that its not just about austerity but also about growth and reform.

News that Fitch ratings is unlikely to downgrade France’s ratings this year has provided a boost to Eurozone confidence. Greece could yet spoil the party given the ongoing discussion with the Troika (Euuropean Commission, International Monetary Fund and ECB) to finalise the second bailout package for the country. Opposition resistance within Greece suggests that more austerity may not be easy to implement. Meanwhile there are ongoing questions about the extent of writedowns that Greek debt will undergo. Despite these issues it appears that markets are becoming somewhat more immune to events in the Eurozone. While still high bond yields for Italy and other debt still point to ongoing trouble, risk appetite has firmed.

One factor that is helping to boost sentiment is the encouraging news out of the US. Although the Q4 earnings season has not began particularly well data releases look somewhat more positive. Not only has positive impact of last week’s US December jobs report continued to filter through the market but so has other news such as a pick up in small business confidence and a rise in consumer credit. These lesser watched data highlight the gradual recovery process underway in the US and the growing divergence with the Eurozone economy and support the view of medium term USD outperformance versus EUR.

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