The US dollar is higher with European equities trading deep in the red following a loss at the polls by Angela Merkel's Christian Democrat party and continued negative news stemming from the Greek/Italian debt crises. The Europeans are in need of a policy response but with Merkel reeling from the recent loss at the polls the most likely candidate to support the EUR will be the ECB.
The losses in the local election in Mecklenburg-Vorpommern appear to be the fallout from the recent euro zone crisis and public opinion on Merkel's handling of the situation. What is most troubling is the defeat comes on Angela Merkel's home turf. While Merkel has been a staunch proponent of fiscal conservatism both in Germany and in peripheral Europe her ability to win points at the polls has suffered with the intensifying euro zone debt crisis. This has pressured European equities which have begun the week with sharp losses. The German DAX is down 3.79% while the London FTSE 100 is off 2.33%. French bank stocks are also taking a hit.
Also driving European markets lower is the continued pressure on both Greek and Italian debt. The Troika abruptly ended their review of Greek finances early but pledged to return to continue the review on September 14th. Bank of Greece Governor George Provopoulos said in an interview with the Kathimerini newspaper, "In my assessment, the recession would be shallower if the reforms progressed quicker, if fiscal deficits were reduced more drastically and if competitiveness were improved." Though the increased austerity measures may be deepening the recession with reduced government spending negatively impacting GDP which could contract by -5.5% from a forecasted -4.5%. The two-year Greek note is trading at an all-time high of 49.69% and highlights the pressure in Europe.
Italian 10-year yields have also risen for the 11th consecutive day as a general strike in Italy is set to take place tomorrow with Prime Minister Silvio Berlusconi pushing a EUR 45.5 billion austerity package through parliament. The ECB was rumored to be in the market today buying Italian and Spanish debt in an attempt to keep the 10-year yields stable near the 5% level. Later today the ECB will announce its sovereign bond purchases made in the previous week.
The Europeans are in need of someone to step up with a policy response to support the EUR and stop the equity losses. Given Merkel's defeat at the polls the Chancellor has been weakened slightly. Thus the next likely candidate at this stage is the ECB, though market participants will have to wait until Thursday for the ECB press conference .
Given the stresses in the European financial system the EUR has also come under pressure across the board with the EUR/USD dropping as low as 1.4120 just off of the 61% retracement from the July to August move. The next support to the downside is 1.4050 and a break here could have scope to the long term trend line at 1.3975. The EUR/GBP is quickly encroaching on its support at 0.8640 from the August 5th low while the EUR/JPY has broken below the 109 yen support and its next test comes at 108. A close below this support could open the door to the post tsunami low of 106.27.
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