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Political uncertainty resurfaces in Spain, Italy

The euro plunged from a 14-month peak against the dollar and the yen at the start of the week, as political uncertainty rekindled concerns over the European debt crisis. The single currency suffered its sharpest drop since June of last year on Monday, amid corruption allegations against Spanish Prime Minister Mariano Rajoy and growing popularity of former premier Silvio Berlusconi in Italy.

In Italy, growing support for Silvio Berlusconi spooked investors
- Emman Xuereb

Forex investors offloaded their long positions in the common currency and booked profits, as growing political uncertainty soured optimism that the currency bloc was healing from its debt crisis. EUR/USD traded as low as 1.3458 from its recent peak by 1.3711 hit last Friday, following the US non-farm payroll report.

A corruption scandal involving Spain’s Rajoy blew up over the past few days, pushing 10-year bond yields to six-week highs while stocks plunged. Rajoy faced calls for his resignation as reports about illegal payments surfaced. He rejected accusations of received illegal cash payments, and promised to post his tax returns online so that “truth may prevail”. Meanwhile in Italy, growing support for Berlusconi spooked investors. Polls showed that Berlusconi was closing the gap on election favourite Pier Luigi Bersani, despite the fact the former is appealing a four-year prison sentence for tax fraud.

Italian bonds and stocks, like Spain’s, also fell, as investors shunned risk and highlighted the fragility and vulnerability of the area’s indebted nations. Any fresh political instability could likely undermine any sense of investor confidence.

Risk aversion that hit the markets at the start of the week, helped to ease some selling pressure off the yen. USD/JPY fell from its 33-month peak of 93.18 on Monday, to 91.98 on Tuesday, however strong expectations of more stimulus in Japan are likely to keep the Nipponese currency in check.

Appetite for risk recovered by Tuesday, as European stock markets staged a comeback, and the single currency recovered from its earlier slump. Sentiment was buoyed by stronger-than-expected results from the services sector. Purchasing managers’ surveys from the eurozone showed activity in this sector shrank less than initially forecasted. While the PMI reading for the euro area rose to 48.6 in January versus an initial forecast for 48.3, in the region’s largest economy, Germany, the reading jumped to 55.7 versus previous estimates for 55.3.

EUR/USD bounced back from a one-week low earlier in the session on Tuesday to 1.3569, by the time of writing. The pair should resume its bullish trend in the near to medium term, with strong support seen by 1.3439, the 38.2 per cent Fibonacci retracement of this year’s advance. The next upside target is represented by last week’s high of 1.3711. A break and close of this level should give scope for further upside gains to test a critical resistance level by 1.3830, which is the 61.8 per cent Fibonacci retracement level of the May 2011 to July 2012 sell-off. EUR/JPY also recovered after falling sharply at the start of the week. The cross rebounded from its low of 124.02, to 126.72, just shy of its recent peak of 126.97 hit last week. A break of last week’s high should pave the way for more gains to test April 2010 high of 127.90.

As the economic outlook in the UK remains persistently pessimistic, the British pound came under renewed pressure at the end of last week and extended its recent declines. As Britain stands on the verge of a triple-dip recession, the sterling plummeted against the euro and the dollar. GBP/USD fell to 1.5675 last week, a six-month low, while EUR/GBP extended gains to 0.8717 – its highest since October 2011. The pair remains firmly bullish, with targets set around October 2011 highs by 0.8831.

The Reserve Bank of Australia kept rates at a half-century low earlier this week, at three per cent as widely expected. In a statement following the RBA’s decision, Governor Glenn Stevens left the door wide open for further easing in the coming months. He said policymakers had more room to cut to a record low, given that the inflation outlook provided scope for more easing, while the jobs market remained weak. AUD/USD fell to 1.0379 on Tuesday following the RBA’s decision.

Upcoming FX key events
Today: ECB Rate Decision, BoE Rate Decision and Asset Purchases Target. Tomorrow: Canadian Unemployment Rate.

Technical key points
EUR/USD is bullish, target 1.3830, key reversal point 1.3125.
EUR/GBP is bullish target 0.8830, key reversal point 0.85.
USD/JPY is bullish, target 95.0, key reversal point 83.90.
GBP/USD is neutral.
USD/CHF is neutral.
AUD/USD is neutral.
NZD/USD is neutral.

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RTFX Ltd is licensed to conduct investment services business by the Malta Financial Services Authority. This information does not constitute an offer or solicitation and is provided for information purposes only. This information shall not be deemed to constitute advice and should not be relied on as such to enter into a transaction or for any investment decision. Any opinions expressed in this document represent the views of RTFX at the time of preparation. They are subject to change without notice. RTFX believes that the information contained herein is accurate as at the date of publication. No warranty of accuracy is given by RTFX and no liability in respect of any errors or omissions, including any third party liability, are accepted by RTFX or any director, officer or employee.

Emman Xuereb is a trader at RTFX Ltd.

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