Spain moves to the epicentre

Risk appetite has continued to firm but caution prevails. Rumours overnight of a Eurozone bank rescue fund (later denied) helped sentiment, but the ECB’s rejection of plans to recapitalise Bankia in Spain via an injection of EUR 19 billion of sovereign bonds and a downgrade of Spain’s credit ratings, once again brought a dose of reality back to markets. Additionally a Xinhau news agency report that China has no plans to introduce a major stimulus package will also dampen sentiment. Against this background it is difficult to see any rally in risk being sustained.

Admittedly equity valuations look more compelling, with the price / earnings ratio on the S&P 500 below its long term average, but that does not mean that now is the time to buy stocks or risk assets in general. The USD remains the winner on the FX front and will continue to edge higher over coming days and weeks, with the currency interestingly verging on a close above its 100 month moving average.

Once again the EUR has failed to hold onto gains, with the currency making lower highs and lows, dropping below 1.2500 overnight. Even a firmer tone to equity markets and slightly better risk appetite has failed to provide any support to EUR as Greece passes the baton to Spain as the new epicentre of market attention. A new poll showing increased support for pro bailout parties in Greece has helped to alleviate Greece concerns slightly there.

Today’s data slate in Europe will come as little relief to the EUR. A further deterioration in economic confidence surveys in May will only serve to highlight the growing growth disparity between the Eurozone and US although the surprisingly large drop in May US consumer confidence was hardly encouraging. The data will leave the EUR vulnerable to further slippage and follow through below 1.2500, with a test of technical support around 1.2300 on the cards.

Like most other currencies the sensitivity of USD/SEK to risk aversion has increased over recent weeks. According to my calculations it has been one of the most highly correlated currency pairs with Risk Aversion over the past 3-months. This has been reflected in the drop in SEK against the USD which accelerated during May. However, USD/SEK has stabilised lately while EUR/SEK has dropped sharply.

A further drop to around 8.95 (trend line from beginning April) is on the cards in the near term but further SEK gains are unlikely unless risk aversion improves. On the positive side, Swedish economic data is at least perking up as reflected in the bigger than expected jump in May consumer confidence yesterday. GDP data today ought to confirm that the drop in growth in Q4 will not be sustained, which will to provide short term relief to the SEK.

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