Spain sends jitters across the markets

The euro was regaining some support last Friday after hitting four year lows on Wednesday of last week. However, in Monday's opening the Spanish banking sector was sending jitters to markets after the Spanish Central Bank announced that it had taken over the running of Cajasur savings bank over the weekend. Needless to say the euro continued its demise trading back to lower levels.

Looking closer at the short lived recovery we had at the end of last week, it was not only alimented by short covering (EUR / USD traded higher as stop losses became effective, and short positions were closed), but also because to a certain extent the European debt crisis was no longer under the limelight - as the prospects of a worldwide crisis was attracting greater concern.

In fact, at the end of last week, while risk aversion was up, US equity indices down and VIX index (an index for implied volatility) up - one would have expected the US dollar to go up too, but instead the US dollar lost ground. This possibly highlights what seemed to be a pull back on European funding concerns paired to a growing concern about the backdrop in the broader global economic recovery. This development has now been cancelled given that the eurozone woes are on the rise again and European funding concerns are back in the limelight.

Spain's aid to one of its banks triggered renewed concerns to such a level that central banks were reportedly selling euros from their reserves to reduce risks to their portfolios. There are reports that on government's encouragement, four Spanish savings banks are planning to merge to form the nation's fifth largest financial group.

Even the IMF (among other issues) urged Spain to radically overhaul its union-dominated labour markets, while it fully supported austerity measures presented. What worries the markets is if the Spanish austerity measures are politically achievable now that unemployment is at 20 per cent and the Spanish government proving to be very unpopular at the moment.

This political unpopularity is not an issue only for Spain - most European governments are already strained by unpopularity (Italian Prime Minister Silvio Berlusconi is another example) and as these governments rush to propose new austerity plans for their countries, planning to bring down deficits in relatively short time, they have to balance disciplined budgets with the well being of their constituents because they know they will have to face their electorate at some point in time.

The downside target for EUR / USD early this week was its four year low (already hit last week) at 1.2143; and after that the next psychological support lies at 1.2000, where most stop losses are believed to have been set.

Last Monday the United States and China met for a two day strategic and economic dialogue in Beijing with talks ranging from economics to politics. The United States suggested the European debt crisis would minimally impact global growth - adding that the global economy was strengthening faster than expected, but China seemed less optimistic and aired its concerns that Chinese exports could be negatively impacted by decreasing European demand. It also said exports from other world regions could suffer from similar reductions of European demand.

Some analysts are suggesting that China might be delaying a rise in the yuan currency rise on concerns that exports to Europe will suffer. Even Japan raised similar concerns, and investors were questioning Europe's political will to effectively control deficits and sluggish growth.

China hit back at the United States, by expressing concerns on United State's budget deficits. In response to this, United States Treasury Secretary Timothy Geithner promised to embark on greater fiscal discipline once it was sure the economy was growing safely.

With risk aversion switched to "on" commodity linked currencies like the Australian dollar, New Zealand dollar and Canadian dollar saw downside pressure. Fears of a frail economic recovery sparked an unwinding of carry trades, hence dampening support for high yielding currencies like the Australian, Canadian and New Zealand dollar. In fact all three currencies were down considerably against most major counterparts.

These unwinding carry trades fuelled support for the Japanese yen. However, analysts still believe that these commodity linked currencies will still find support from rate differentials and growth in the medium to longer term.

To further add insult to injury, tensions between North and South Korea were an added geopolitical concern on top of the prevailing financial crisis. Markets reacted by a mass exit from risk on Tuesday. North Korea is accusing South Korean navy of trespassing into its waters, while South Korea accuses the North of firing a torpedo at a navy ship killing 46 sailors. The prospects of military conflict have started being felt.

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Upcoming FX Key events

Today: US PCE Core and GDP Preliminary.

Tomorrow: US Michigan Consumer sentiment index.

FX Technical Key points

EUR/USD is bearish, target 1.20, key reversal point 1.3200.

USD/JPY is bullish, target 98, key reversal point 85.

GBP/USD is bearish, target 1.4000, key reversal point 1.5700.

USD/CHF is bullish, target 1.2000, key reversal point 0.9950.

AUD/USD is bearish, target 0.7800, key reversal point 0.9400.

NZD/USD is bearish, target 0.6200, key reversal point 0.7650.

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Mr Bovay is senior trader at RTFX Ltd.