Caution ahead of EU Summit

Risk appetite has continued to firm over the last few weeks although notably risk is still elevated compared to the the levels seen in May, suggesting that there is some way to go before risk appetite normalises. Improving risk appetite perhaps reflects rising expectations of a credible set of solutions to the Eurozone crisis but various summits and official meetings including the G20 meeting have failed to deliver anything of this nature.

Attention will turn to the EU Summit on 28-29 June where various issues ranging from debt mutualisation to fiscal and banking union as well as a potential renegotiation of Greece’s bailout terms, will be discussed. Markets are likely to remain relatively range bound ahead of the Summit.

There are also plenty of data releases to contend with over coming days including new home sales, consumer confidence and durable goods orders in the US as well as flash CPI inflation estimates, economic confidence gauges and Italian debt auctions in the Eurozone. Japan will release inflation data too and industrial production data.

On balance US data will continue to outperform although consumer confidence is likely to slip in June. In Europe, confidence indices will reveal some further deterioration in June, while in Japan weak industrial production and a drop in monthly inflation will maintain the pressure on policymakers to act in the country.

The USD will continue to find support from the fact that the Fed did not implement more quantitative easing but firmer risk appetite will cap the ability of the USD to strengthen much from current levels. It is notable that the USD long positions dropped sharply according to IMM data ahead of the Fed meeting but it is likely that Fed QE inaction will result in some rebuilding of USD longs.

In any case, given the uncertainty ahead of the EU Summit it is unlikely that the EUR will break out of its current ranges. Notably there was a major bout of EUR short covering last week, with EUR/USD shorts dropping sharply according to the IMM data. Hopes ahead of the EU Summit may encourage more short covering but as usual scope for disagreement and disappointment on many fronts, suggests that investors should not become overly bullish. EUR/USD will find some initial resistance around 1.2583 to any upside.

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