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The market is digesting the details of the Cyprus bailout deal, and while infinitely more preferable to the initial bailout plan complete with haircuts for all deposit holders; the plan isn't seen as the panacea to Cyprus's or to the Eurozone's problems. The market initially bounced to 1.3050 on the news early this morning that Cyprus had secured its funds and had narrowly avoided financial Armageddon, but over the course of the London morning those gains have steadily evaporated. EURUSD has, so far, reached intra-day lows around 1.2915. There are two things that are driving caution in the EUR trade: 1, fears of implementation risk, Cyprus still has some hoops to jump through before it gets its hands on the EUR 10 billion. The bailout deal still needs to be ratified by the German and Dutch parliaments. While this is expected to pass, there is a risk of some opposition in Berlin especially as we are less than six months away from Federal elections in Germany. 2, Italy. The country is still without a government. The President Napolitano asked the head of the centre-left, Bersani, to form a government, yet, so far, the conversations have been fruitless.
EURUSD could trade with a slightly bearish bias in the run-up to the German Parliament vote on Cyprus, a date for which has yet to be announced. However, we think that the downside could be limited (bar some adverse risk off event like the German parliament doesn't approve the Cypriot bailout) and we could trade between 1.2880 (last week's key support zone) and 1.3130 - the 100-day sma. 1.2850-80 looks like a mini low for now. The trend bias looks sideways, with bears unable to get a break to the downside. I have had a lot of questions about why the euro has been so resilient and failed to crash even with the uncertainty caused by the events in Cyprus. My answer is two-fold: 1, the ECB has promised to provide solid (read insolvent) financial institutions with all of the money they need, which is helping to keep a lid on volatility. 2, The recovery in the US, although gathering steam, is still tentative and the US authorities don't seem to want to rock the boat and end QE3 too early. For Europe a weaker euro could reap dividends, and based on growth trajectories the euro should be comfortably sub 1.30 versus the dollar.
We think this will happen, but we may need a few more data points from the US to confirm the strength of the recovery, first. We don't want to see a bounce in growth in Q1, only for sentiment to wane as we move through to the middle of the year, as we have seen in the last couple of years. But one thing is for sure - the outlook for Europe, which has a triple whammy of defects, including political, economic and sovereign crises, is much bleaker than the US. The latest "bad news" stories to hit the Eurozone include Moody's view that Italy's economy will shrink 1% this year, and the downgrade to Germany's 2013 growth forecast from the German Council of Economic Advisors from 0.8% for this year to 0.3%. This makes the ECB's forecast that growth will pick up in the second half of this year even harder to achieve.
GBP gains capped
The pound has backed away from 1.5250 highs today. While the pound was looking extremely oversold last week and was due a pullback, we think gains will be limited due to the UK's weak economic profile and also the prospect of more QE. There isn't too much economic data out for the UK this week apart from the final reading of Q4 2012 GDP, released on Wednesday. The market expects no change to the -0.3% reading, but there is a chance there could be a downward revision to the -0.4- -0.5% zone, on the back of some weak trade data. If this happens, we think it would be another reason for GBP longs to take profit as we see the upside as being capped ahead of 1.5300. The short term bias is lower in GBPUSD below 1.5210 - the daily pivot, support lies at 1.5155 then at 1.5120.
Stocks squeeze out some more gains
There is a lot to be gloomy about in Europe, so where are the bright spots? The equity markets are still in positive territory and the bulls continue to try and push higher, although the rally is tentative to say the least. At the moment, I would not look to buy global stock markets at these levels as the chance of a risk event in Europe remains high. We have seen European and US stocks alike both react to risks emanating from Cyprus, thus we don't think that US stocks are immune from European risks, especially as they remain close to record highs. Rather than say we are bearish on equities (we are not) we are more agnostic. A sell off could provide a buying opportunity, but we think that stocks have two key event risks to deal with: 1, European issues and 2, the threat of an end to QE... Both of these could prove fatal to the stock market rally we have seen in recent months. However, before that happens we could push to a fresh record high in the SPX 500 - as we hover close to the 1,567 highs.
Elsewhere, the Aussie is continuing to extend gains today after breaking above key resistance at 1.0420 last week. Above 1.0480 opens the way to 1.0550 then to 1.0600 - the top of the recent range that stretches all the way back to early 2012. The bias is higher above 1.0465 in the short term, support lies at 1.0450 then at 1.0380.
One to Watch: Break-out watch for AUDUSD
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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