FX Weekly Report (20/07/2012) Spain's liquidity issues dent market confidence (page 1 of 2)

With Europe on the backburner for the past few days, risk sentiments were tentatively elevated and delicately poised amidst a solid Q2 earning season from the US - however the optimism was short lived as Spain's liquidity issues rocked investor confidence and setup a strong downside breakout for Euro based crosses.

Markets were shook on Friday as the region of Valencia formally requested financial aid from the Spanish government as it struggles with the refinancing of its debt load. With close to €3 billion Euros required in funding, it is the second region after Catalunya to turn to the central government since May; and hopes to tap into the €18 billion Euro program.

The announcement immediately brought the EU funding issues back into center focus and reminded the markets of the liquidity crunch engulfing Europe and with this latest reminder, the financial markets tanked across the board. The Euro which dropped more than 130 points against the US Dollar to make a new two year low at 1.2144, the lowest levels since June 2010.

Similarly, EURGP slipped to a new historic low of 0.7782, while EURJPY dropped to 95.42 levels. The Spanish equity index encountered it's second largest single day drop in close to four years (down -5.82%) while Spanish borrowing costs shot up with yields popping up 29 basis points to take the Spanish 10 year to 7.30% levels. And to complicate matters further, Spain also downgraded its economic forecast on Friday, confirming that the Spanish economy is set to shrink by 0.5% in 2013, as compared to a growth of 0.2% as previously expected.

For so much of the week, EURUSD found solid support at 1.2250 levels, boosted by spurts of optimism from an improved Q2 earnings season out of the US. Instead, the latest Spanish announcement saw the pair close the week well below the previous weekly low of 1.2162 - making the technicals of the pair equally as unattractive as the negative fundamentals drivers from this past Friday. Judging by the ferocity Friday's breakout, that June 2010 low of 1.1876 is very much on the cards for EURUSD.

With so much negative sentiment already weighing down EURUSD, perhaps the only savior for the cross would be another round of easing from the Federal Reserve which would impede the recent bull run of the US Dollar. However Fed Chairman Ben Bernanke's testimony this week in front of the Congress and the House of Representatives over a two-day session will surely take the wind out of those sails.

During his testimony on Tuesday, the Fed Chairman painted a rather bleak picture of the US economy but refrained from addressing the need for any immediate, near-term monetary stimulus. He admitted that US Jobs growth has been and will continue to be 'frustratingly slower' and said easing tools include further purchases of assets (such as mortgage-backed securities), reducing the deposit rate or altering the communications of interest rate outlooks could be employed if the economic conditions in the US deteriorate significantly. However Bernanke stopped short and noted that the 'side effects and risk that may be associated with such programs should not be taken lightly.' Bernanke's comments come as no surprise however, particularly after the FOMC's most recent meeting minutes showed no action towards more accommodative policy.

Although it seems that another round of aggressive measures cannot be avoided, the time frame is more likely to fall at some point in Q4, when the extension of the Operation Twist program is set to end.