Reality Check

Markets face a reality check going into this week. The euphoria emanating from recent Fed, ECB and BoJ actions is fading quickly. The reality of weak growth and underlying structural tensions is coming back to haunt markets, suggesting much more limited upside for risk assets over coming weeks.

While there are some positive indications that the growth outlook may not have much further to deteriorate, such as the bounce in the Baltic Dry Index, scepticism about the ability of central banks to reflate economies is growing. In this respect, its worth highlighting that the rally in gold prices failed to extent much further last week although in part this may be due to an options expiry tomorrow.

Renewed tensions are creeping back into the market psyche, especially with regard to Europe. Procrastination from Spain about a formal bailout threatens to weigh on markets in the days ahead as some officials suggest that the EUR 100 billion received for Spanish banks will be sufficient for the country to avoid needing further aid. Bank stress test results, a Moody’s review on Spanish ratings and the country’s 2013 budget will all be scrutinised over coming days.

Meanwhile, disagreement between Germany and France over the timing of introducing banking union and supervision is accentuating tensions in the region. Greece remains in the limelight too, as the government continued to find further budget cuts in order to receive the next tranche of loans. The only good news appeared to come from a German press report that the ESM permanent bailout fund’s firepower will be leveraged up to EUR 2 trillion.

The EUR has lost momentum following its initial surge higher and looks constrained on any move above 1.3000. While EUR short positions have continued to be pared back according to IMM data the scope for short covering is becoming more limited. Developments in Spain and Greece will provide further guidance for the currency, but any upside in EUR/USD will be limited to resistance around 1.3180. It seems more likely that having failed to sustain gains, the EUR will continue to drift lower.


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