Risk sentiment soured as political risk increased in the Eurozone which drove sovereign yields higher and the euro lower. The common currency is weaker against all of its G10 counterparts after Spain’s opposition called for Prime Minister Rajoy to resign amid accusations of his party accepting illegal payments. Rajoy denied allegations and German Chancellor Merkel backed the Spanish PM. In Italy, former PM Berlusconi is making a strong showing in the polls ahead of elections. Current PM Monti pointed out that Berlusconi presents risk which is increasing the country’s yield spread. EU sovereign yield spreads are higher across the board which is weighing on the euro. EUR/USD looks set to form a bearish engulfing candlestick on daily charts which suggests the potential for a deeper correction. However, the longer term trend remains intact and shows no signs of reversal yet.  

With the European Central Bank (ECB) meeting later this week on Thursday, it is likely that we may see the euro consolidate prior to the policy announcement. President Draghi’s press conference will be significant as markets will watch to see if he addresses the exchange rate. Many of the other major central banks around the globe have expressed concern regarding exchange rates and so far the ECB has been reluctant to join the “currency wars”. However, with a strengthening euro at a time when the region’s economy is mired in a recession, there is risk of the central bank addressing the currency. For now, the 1.35 zone in EUR/USD is a key technical pivot as the 50% retracement of the decline from 2011 highs to 2012 lows converges with the 2012 highs just below the big figure.

In the US, factory orders disappointed with growth of only 1.8% in December (cons. 2.3%) while the prior month’s change was revised down to -0.3% from the previous 0.0. Dallas Fed President Fisher (non-voter and known hawk) suggested tapering asset purchases and questioned the impact of QE on the labor market.

US equities experienced sharp declines in what appears to be a corrective move lower within a bullish channel. The Dow Jones Industrial Average slumped by about -0.93% and the S&P 500 dropped by around -1.15%. US treasury yields are lower across the curve amid a decline in risk sentiment and the 10-year yield is currently lower by about 5.66bps to 1.9584% which is a factor weighing on USD/JPY today.

Data watch

The key event tonight is the Reserve Bank of Australia (RBA) meeting. We expected the bank to pause in its easing cycle for now and keep rates steady at 3.00% as the RBA monitors economic data. Though domestic data has been disappointing, the Bank has noted that “the full effects of earlier measures are yet to be observed” and in our view, this highlights the bank’s preference to sit on the sidelines for now. As such, the tone of the statement is likely to drive price action in the AUD with a dovish bias to weigh on the currency while a more neutral stance may be supportive.

Australia will also see December trade balance figures which are expected to show a narrowing deficit and the 4Q house price index is also due out tonight. Elsewhere, China’s private sector services PMI reading will be released.

Source: eSignal, Forex.com