Risk Sentiment To Remain Subdued As The Market Digest Downgrades

O/N BULLETS

• IMM data shows net EUR shorts increase further in the week ending 10 January
• Merkel calls for Fiscal efforts to be stepped up after S&P downgrades

USD 

The USD index traded higher and made new highs after intense speculation of broad sovereign downgrades to Euro area countries Friday afternoon. U. of Michigan confidence was much stronger in January, but this was largely overshadowed by events from Europe. Europe remains the key focus for this week, with on-going talks between Greece and the IIF and French and Spanish bond auctions on Thursday. For today, risk sentiment will likely remain subdued as the market digests the recent rating downgrades and the upside bias to the USD will likely continue.

EUR 

A flurry of headlines of potential downgrades to Euro zone countries saw EUR/USD move sharply lower on Friday afternoon. The S&P announced downgrades to 9 Euro area countries late Friday evening. Italy and Spain were cut by two notches while France and Austria were downgraded by one notch, both losing its AAA rating. Merkel's response was to call for speedy introduction of the ESM and for the fiscal compact to be signed quickly, potentially by the end of the month. But given the lack of immediate impact as the implementation of fiscal rules is a longterm process, this could see limited market reaction. There had been fears of a possible two notch downgrade to France so the one notch cut should see some market relief. Today's French bill auction could attract some interest, but the focus will be on the French bond auction on Thursday. And on-going discussions regarding the Greek PSI will likely weigh on sentiment towards the EUR.

GBP 

GBP/USD edged lower as risk sentiment turned negative Friday afternoon. But GBP resilience saw gains vs EUR, retracing the losses seen earlier on in the week. The BoE is widely expected to increase their asset purchases at the next BoE meeting; while this could weigh on appetite towards GBP during risk positive periods, GBP will likely remain a preferred safe haven currency and will likely remain resilient should risk sentiment remain soft today.
 
CHF

EUR/CHF continued to edge towards the 1.20 floor last Friday. While EUR weakness will continue to put pressure on the cross, CHF strength will likely be restrained vs USD and GBP. We expect the SNB will defend the 1.20 floor and there will likely be some resistance as EUR/CHF approaches 1.20 should the SNB will intervene.

Spotlight - EUR/USD downtrend remains intact- EUR/USD saw brief upside momentum following optimism from the strong demand at the Spanish auction last week. But the Italian auction on Friday failed to live up to expectations resulting in market disappointment. That, plus numerous headlines of expected downgrades to Euro area countries saw EUR/USD make new lows on Friday. The medium term downtrend we have seen since November last year is still in place. The recent downgrades and concerns of a breakdown in talks between Greece and the IIF on the PSI will likely keep downward pressure on EUR/USD; and the downtrend will likely be with us for as long as EUR/USD remains within the down channel (chart below). There is key support around the 1.26 level, but we see risks of a break lower.