Following the bustling Monday session in which a huge spike in volatility took place, global financial market barely got out of second gear yesterday (Tuesday), in what may be interpreted as a consolidative transition. The question now is, was that the calm before another storm or can ailing risk assets enjoy some room for further corrections?
Overall, judging by the moves in the EUR/USD and other asset classes, there is still no evidence to suggest a meaningful recovery is on the cards. As Adam Button, editor at Forexlive, notes:
I would have expected a rebound in the hardest hit trades - like EUR/JPY, especially given the lack of tape bombs from Italy and the upbeat U.S. economic data today.
Will there be further attempts by the markets to rebound today? The best guess is that price activity still faces high risk of being disrupted on a headline-by-headline basis amid the high uncertainty surrounding the Italian political landscape.
In the next days, even weeks to come, traders should gear up for the euro fate being strongly dependable on the direction that the Italian government is headed, as this directly impacts the allure of the Italian bond market - yields were up by 40bp yesterday, the Italian bourse fell almost 5% -, which continues to be finely correlated with the performance of the single currency.
According to Kathy Lien, co-founder at BK Asset Management:
We believe that the key lies in Italian bond yields.
If borrowing costs continue to rise for the rest of the week, it may be difficult for the EUR/USD to hold above $1.30. However if yields start to decline and the market seems pleased with a potential Bersani / Berlusconi coalition, it would be a stronger argument for a recovery in the EUR/USD.
Fundamentally, it is hard to see how Italian politicians can turn the tide around. While there might be some plenty of intraday risk headlines in both directions, expect both Mr. Berlusconi and Mr. Bersani to stick to their principles, which suggest chances for a grand coalition are slim. Besides, the other key player, Mr. Grillo, has already turned down cooperation with any or both.
What this does, as Mr. Button reports, is that "it ensures a period of uncertainty and turmoil, which is a recipe for higher yields", adding that "we might see some headlines where politicians sound like they could work together but that is likely an attempt to look pragmatic ahead of another election."
Arguing against Adam's point is NAB, noting that "fresh elections are far from a given", they argue, adding that "it is quite possible that Mr. Berlusconi and Mr. Grillo, following their strong electoral showings, can achieve their aims (and which may include Mr. Berlusconi wanting immunity from prosecution) without having to bring the Italian political system back to its knees."
Another focal point for today will be the second day of Ben Bernanke's Senate Banking Committee testimony, in which risk headlines are never too far. Yesterday, he offered his view on why the benefits of keeping the current QE program continues to outweighs the costs, somehow suggesting that the FOMC is still not ready to start cutting short its QE3 bond buying.
Technically, according to technical strategist William Moore at RBS,
the basing of the market at $1.3040 leads us to think that we'll see the market drift up to $1.3198 possibly even to $1.3269 before we meet any meaningful resistance again.
On the downside, if EUR/USD does fall further, "the next near-term target could be 50% retracement (of $1.2041-$1.3710) at $1.2875. A rally back above $1.3125 could neutralize the bearish outlook for the time being" said Fan Yang, CMT, chief technical analyst at FXTimes, and independent analyst at FXstreet.com
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.