Market Drivers Feb 4, 2013
USD/JPY hits fresh highs at 93.00
EUR/USD unwinds rally on concern over Spain corruption issue
Nikkei 0.62% Europe -0.79%
Oil $96.90/bbl
Gold $1665/oz.

Europe and Asia:
AUD Building Approvals -4.4% vs. 1.1%
NZD ANZ commodity prices 0.3%
EUR Sentix Investor confidence -3.9 vs. -2.2

North America:
USD Factory Orders 10:00

The EUR/USD was under attack from the start of trade today as fears over the growing corruption scandal in Spain and some jawboning from EZ officials sent the pair tumbling through the 1.3600 figure unwinding much of Friday’s rally. The situation in Spain – where the government of Prime Minister Rajoy has been accused of making illegal cash payments – has created a political crisis with many calling on Mr. Rajoy to resign.

Last week the Spanish newspaper El Pais revealed of alleged illegal cash payments, including extracts from handwritten ledgers by the former People’s Party Treasurer Luis Barcenas that showed payments to officials including Rajoy. Mr. Rajoy has denied the allegations stating that he never received those payments.

However, he has come under a vicious ridicule attack by refusing to answer the charges head on in a press briefing, as he opted instead to talk to reporters via a video conference. The calls on Mr. Rajoy to resign are increasing in Spain as the outrage over the matter grows especially in the midst of the deepest recession the country has faced in many years.

The prospect of Rajoy resignation has roiled the markets as any fresh political instability in EZ most important periphery economy could undermine the sense of investor confidence and send Spanish yields higher making it much more difficult for the government to implement its austerity measures. Spanish yields rose about 10 basis points and Italian also jumped higher in sympathy.

The euro, which has enjoyed as massive rally this year, in large part due to the unwind of the “EZ break up” trade was once again under assault as those fears resurfaced. It was particularly weak on the crosses especially against the pound and the Aussie as those two pairs came under very heavy profit taking after rising in a near vertical fashion last week.

The story in Spain underscores the fragility of the recovery in the European sovereign debt markets and shows that political risks could still scuttle the carefully laid plans of Mario Monti to stabilize the financial sector in the region. The recent rise in the EUR/USD has also exacerbated matters as it will make it more difficult for exporters in the periphery economies to grow this year.

The euro therefore is vulnerable to further correction especially if the pressure on Mr. Rajoy increases as the week proceeds. After its massive run up, investor sentiment may now change and the pair could retrace back to the 1.3500 level as markets curb the enthusiasm.

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