Euro And The Italian 'Sequestration'

 |  Includes: FXE
by: FXstreet

The bloc currency remains trapped in this new intraday comfort zone around 1.3320/40, dragged there by the recent horrendous euro area GDP figures yesterday, and further soft data from the EMU's industrial sector this morning. These late data just add to the last dovish tone seen in ECB's Draghi's comments in the February ECB gathering, implicitly targeting the recent appreciation of EUR/USD.

… What lies ahead

In the near term, however, the scenario would favor further weakness of euro sentiment as two big risk events - on the cards, at least - arise in the horizon. One of them pertains to the Italian elections due in late February, just days away. At the moment, Pier Luigi Bersani, leader of the PD party - or center-left coalition - is positioned to take over the Chamber of Deputies although whether this party can take the Senate is another issue. The centre-right party would be the winner in the key regions of Lombardy and the Veneto, throwing Bersani's aspirations to a second place in his run for the majority of the Senate seats. The most probably outcome would be a shared government between Bersani and the technocrats ruled by Mario Monti, although the fragilities inherent to such an agreement could derail in another elections sooner than later. Risk trends from this particular scenario would have an impact on the Italian debt markets and its subsequent spillover into the rest of the peripheral bond markets of the euro bloc, supporting investors' flight-to-security, which is not precisely supportive of the euro.

In addition, time is running out regarding the U.S. fiscal situation, the so-called "sequester" that will ignite spending cuts across the board and directly slash four percentage points off the US GDP. As an example, the Pentagon would have to deal with budget cuts about $500 billion over ten years. Another $500 billion would come as non-defense programs, apart from the damage to the U.S. middle-class, affecting thousands of jobs. The deadline is March 1, and the ball is now in both Republicans' and Democrats' backyard. The former would push for increasing taxes while Democrats look to concentrate their efforts on spending issues. The greenback - measured by the U.S. Dollar Index - in the meantime, has started to sense the proximity of the key date and the yet absent negotiations in order to overcome this tough hurdle, climbing from the boundaries of 78.90 in early February to the current levels around 80.60

All in all, the euro is posed to face increasing headwinds in the upcoming weeks, where the downside would face the first barrier around the 1.3300 handle (55-day moving average) ahead of the area of 1.3230/40 (uptrend line set from mid November lows).

In addition, Karen Jones, expert at Commerzbank, suggests, "The 1.3270/56 band is key near term. This is the 16th Jan low and the 61.8% retracement and 3 month support line. This is likely to hold the initial test - however the risks have increased that we will see an eventual break down through here towards the more important 1.3164 7 month uptrend and a close below here is required to negate the up move completely".

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.