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FX Weekly Report (20/07/2012) Spain’s liquidity issues dent market confidence

Currency markets closed in the red this past week as strong risk off sentiments dominated Friday's trading session.

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. Earlier in the week, the headline US retail sales figure came in much weaker than expected at -0.5% (Exp 0.2%, Prev -0.2%) and was the third consecutive monthly decline.

Despite news from Spain, sluggish retail sales and the lack of action by the FOMC, US stocks traded positively for the majority of the week thanks in large part to a solid start to the Q2 US earnings season. Some of the key earnings reports included Citibank who announced an EPS of 0.95 cents which trumped analysts expectations of 0.89 cents per share. Similarly, Bank of America announced an EPS of 19 cents per share, better than analysts’ estimates of 16 cents a share. And finally, market heavyweight Google announced a net income of $2.79 billion ($8.42 per share) well above the $2.51 billion ($7.68 per share) for the same period a year ago.

Elsewhere around the globe, the International Monetary Fund downgraded their global growth forecasts for 2012 from 3.6% to a revised 3.5%. The Bank of England released their meeting minutes this past week, and amidst the 7-2 voting split which led to the £50 billion increase in the asset purchase target, the bank announced that they would be open to reviewing UK interest rates in the future. The GBP immediately weakened following the announcement but was quick to recover to close the week marginally higher at 1.5620 (+44 points) against the Greenback. The LIBOR scandal gained momentum this week as it was announced that several banks including Citigroup, HSBC, Deutsche Bank and JP Morgan Chase were being sized up by investigators for their role in the rate setting scandal which has already seen Barclay’s fined more than $450 million.

Looking at the week ahead, the Euro is expected to continue it’s free fall as an extension of Friday’s breakout and this will continue to present golden shorting opportunities in the Euro against the British Pound, US Dollar and Japanese Yen – particularly if there is a relief rally as a result of profit taking on all those overloaded shorts from this past week. The economic calendar switches over to the global growth story this week with China, Europe, UK and the US publishing their respective manufacturing and GDP readings. Early on Tuesday sees the release of Chinese HSBC Flash manufacturing PMI, followed by several key PMI readings from the Euro-zone and Germany at the start of the European session. UK GDP data on Wednesday is expected to show further contraction to -0.3% (down from a previous reading of -0.2%) while Friday’s US GDP reading is expected to show growth of 1.6% during Q2 (below the previous reading of 2.0%).