Euro Sell-off, Yen Rally on Pause as Investors Digest Italian Election Results

ASIA/EUROPE FOREX NEWS WRAP

“Pessimo.” This is how one of my Italian colleagues described the election results yesterday – “very bad.” It seems that the majority of market participants would agree based on price action over the past 24 hours: the EURJPY plummeted over six (!) big figures; the S&P 500 fell approximately 30 points from high to low; and Italian bonds imploded.

But what’s “very bad” about the election results yesterday was not the fact that anti-austerity candidates moved up in the polls and received substantial support. The bad part of the Italian election results is that there is now a “hung parliament,” or divided government. The lower and upper houses of parliament share power; thus, when each branch breaks into different ideological directions, the country is essentially at an ungovernable impasse.

The reason why this is weighing on investor sentiment is now it means either: another caretaker government under Mario Monti, who has grown increasingly unpopular amid heightened austerity and record high unemployment; or new elections in a few months. Quite sincerely, the reaction thus far is very similar to what we saw last year in May, when the French and Greek elections ‘went the wrong way’ – political uncertainty creating an air of distrust in the markets. The only difference now is that the European Central Bank has its OMT safety net in place to catch plummeting Italian and Spanish bonds. Continued political uncertainty could force Italy into accepting the terms of the OMT, in order to calm investors. This may have limited downside in Euro-based pairs now; but don’t be surprised by further downside over the coming weeks.

Taking a look at European credit, peripheral yields have started to blowout following the ‘disappointing’ Italian election results. The Italian 2-year note yield has increased to 2.022% (+34.1-bps) while the Spanish 2-year note yield has increased to 2.636% (+7.9-bps). Similarly, the Italian 10-year note yield has increased to 4.771% (+29.2-bps) while the Spanish 10-year note yield has increased to 5.212% (+6.4-bps); higher yields imply lower prices.

RELATIVE PERFORMANCE (versus USD): 11:45 GMT

CHF: +0.57%

EUR: +0.44%

CAD: 0.00%

GBP:-0.05%

AUD:-0.06%

JPY:-0.09%

NZD:-0.49%

Dow Jones FXCM Dollar Index (Ticker: USDOLLAR): -0.06% (+0.82% past 5-days)

ECONOMIC CALENDAR

See the DailyFX Economic Calendar for a full list, timetable, and consensus forecasts for upcoming economic indicators.

TECHNICAL ANALYSIS OUTLOOK

EURUSD: The pair has broken the major uptrend off the July and November lows, breaking at 1.3200/20 yesterday, leading to a cataclysmic sell-off into the January swing lows at 1.2995/3035. Although the EURUSD is near oversold conditions, we note that momentum amid political distress tends to supersede RSI. If 1.2995 breaks, a move into 1.2875 and 1.2660 shouldn’t be ruled out.

USDJPY: The Bull Flag turned out to be a topping pattern, with the 92.30-94.80 range breaking to the downside. Now, with momentum heading lower, and significant event risk on tap, further selling into 90.00/20 would not be a surprise. Barring a collapse in Treasury yields (specifically, the 2s10s spread), the USDJPY remains a long-term buy.

GBPUSD: Selling persists amid weak data, a dovish and divided Bank of England, and the United Kingdom losing its revered ‘Aaa’ rating. The opening gap this week was filled at 1.5160 after opening at 1.5072, suggesting that further downside may be in the cards. With uncertainty prevalent on the horizon – the US budget sequester coming on Friday – and the Federal Reserve tilting more hawkish, it’s possible to see a break below 1.5000 this week. With the ascending trendline off of the 2009 and 2010 lows breaking, as well as the 2010 to 2013 range bottom lows breaking near 1.5300, my bias is to sell rallies.

AUDUSD:No change: “The bounce from the 1.0265/90 area may have completed, with the rally halted at the 200-DMA at 1.0305/10. The pair is sitting at the 100% extension at 1.0265 now, and a break implies a deeper setback towards 1.0135/75, early-September and –October swing lows, as well as the 161.8% extension. Although there was an overshoot into 1.0360, former support, failure has occurred, signaling further downside is possible. Price has struggled further to overcome this level. I’m still looking for a move into 1.0135/75.” Note: a potential Morning Star candlestick cluster – a bullish reversal pattern – may be forming on the daily chart.

S&P 500: No change: “The 100% Fibonacci extension on the fiscal cliff rally and flag comes in at 1530. Bottom line: I’m expecting a significant setback (-10%) in the S&P 500 unless volumes accelerate rapidly, given the disconnect from reality. The setback has started, with the S&P 500 reversing sharply off of 1530, and putting in a daily Bearish Key Reversal yesterday. Time to start looking lower. Support comes in at 1500 and 1475. Resistance is 1520 and 1530.”

GOLD: No change: “Gold broke below trendline support off of the January 2011 and May 2012 lows at 1650 last week, prompting a sharp sell-off into 1600, where price broke out in mid-August before a rally into the post-QE3 high at 1785/1805. However, with oversold conditions persisting on the 4H and daily timeframes, a rebound should not be ruled out; each of the past two daily RSI oversold readings has produced a rally in short order. Resistance is 1625 and 1645/50. Support is 1585 and 1555/60. It should be noted that Gold has entered a major support zone from the past 18-months from 1520 to 1575.”

— Written by Christopher Vecchio, Currency Analyst

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

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Euro Sell-off, Yen Rally on Pause as Investors Digest Italian Election Results