Support For Rajoy in Regional Elections Will Give Confidence To Euro Currency

Dollar Rises on Risk Aversion, Looking ahead to the Fed
GBP: Supported by Drop in Borrowing Needs
CAD: BoC Could Tone Down Hawkishness after CPI
NZD: Could RBNZ Grow More Dovish?
AUD: Gold and Oil Prices Fall Sharply
JPY: Japan Warns of Impact of Rising Yields

With no significant data or events timetabled for today, attention will be on key releases and the FOMC later this week. Last week a risk positive tone was to the fore. However, with no decisive progress on euro area bailouts or the US ‘fiscal cliff’, and the global economic data still decidedly mixed, there are concerns that markets may be getting ahead of themselves.

The UK data showed a marked improvement is finances that showed borrowing remained capped at last year’s levels despite the slowdown in the UK economy. The news kept cable relatively well bid above the 1.6050 level and the unit improved against the Euro with EURGBP trading lower by 20 points in the aftermath of the release.

On Friday, at the EU summit European leaders continued to work on long range plans for further fiscal integration but made only modest progress on the issues. With respect to banking union the leaders decided to first establish a regulator with implementation to take place during the course of 2013. Therefore no banking union will occur until a regulator is in place leaving the region with a fractured banking sector at least until the start of 2014. Some analysts have argued that a banking union in the EZ is perhaps even more important than a fiscal union, so it will be interesting to see if this gradualist approach will be enough to satisfy the market.

As to the idea of further burden sharing and fiscal integration the leaders decided to push back the discussion to their next meeting in December. Clearly there remains serious disagreement within the EZ as to the extent of integration the members are willing to assume.

Overall the EU summit is producing little new policy initiatives so far, and that lack of action is being reflected in the market as the enthusiasm of Euro longs has clearly diminished over the past few days with the pair failing to take out the 1.3150 barrier this week and now in danger of slipping back to the 1.3000 level as progress on the fiscal crisis in Europe remains slow.

On the economic front the EU current account printed lower than expected at 8.8 Billion versus 11.3 while in UK Public sector net borrowing improved to 10.7 Billion versus 11.9 Billion.

Concerns about the outcome of this weekend’s regional elections in Spain and disappointment in the lack of progress at this week’s EU Leaders Summit have driven the euro lower against the U.S. dollar. The stakes are high for the Prime Minister of Spain and Europe as a whole because the outcome of election will impact the government’s decision on a bailout. It is widely believed that the Spanish government’s reluctance to ask for bailout has a lot to do with the upcoming elections. Prime Minister Rajoy’s People’s Party is worried that they could lose part of their 38 seats in the 75 member regional assembly. Considering that the Party commands a very small majority, if any seats are lost, the Socialists and Galician nationalists could push for a coalition government. The elections will be an important test of the people’s satisfaction with Rajoy’s government and his handling of the country’s fiscal and economic crisis. If the People’s Party holds onto all 38 seats, the Prime Minister would feel more confident to ask for a bailout, which would be positive for the euro. However if the party loses power, it would be a huge blow to Rajoy and could push him to delay a bailout request until after the Catalonia regional elections in November, prolonging uncertainty in the Eurozone, which is negative for the currency. Galicia is the fifth most populous region in Spain but Catalonia is much more important because they are not only the second most populous region but also Spain’s most powerful economic center. While the riots in Spain suggests that the party is at risk of losing its majority, a survey conducted by La Voz de Galicia newspaper saw the People’s Party remaining in power. Also Galicia is where the Prime Minister is from and home of the late founder of ruling party. The Basque County will be holding elections on the same day as Galicia but the nationalists have dominated this region. Once again the stakes are high for Prime Minister Rajoy and the euro.

It looks hard to see major gains in EUR/USD without Spanish applying for EU assistance, and Rajoy’s comments on Friday suggested they were not any closer to a decision, but with market expectation that Spain will make a request at some point, this should keep EUR well supported. The regional Spanish elections overnight we as expected and with Rajoy maintaining a majority in Galicia, this could see some market relief and keep EUR supported.

The greenback is traded higher against all of the major currencies Friday morning despite weaker housing market data. Existing home sales dropped 1.7% in the month of September after rising by the strongest amount in 12 months. A pullback after a solid month is natural but the continual decline in the average price of a home sold indicates that there is still weakness in the sector. Softer U.S. data added pressure on risk appetite and drove equities lower.

The contents of this report are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The author(s) cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.

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