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Fundamental Afternoon Wrap: Europe on edge as Italian vote looms on horizon

This afternoons institutional research has understandably carried a heavy focus on European goings on, with the LTRO repayments coming in much lower than expected, indicating that fundamental conditions on the ground are not as good as previously expected. Also, the Italian election is the key event on the horizon with the prospect of yet another Berlusconi resurgence causing markets general discomfort.

EUR/USD

Brown Brothers Harriman analysts note that there have been several notable developments in Europe, with the key being that European banks are prepaying a much smaller-than-expected amount of the second LTRO than markets anticipated, just EUR 61.1bln next week, with expectations close to EUR 125bln. They feel that this means that the passive tightening in the Euro area financial conditions is not as great as the market had discounted and so the Euro returned to yesterday´s low. Meanwhile the also note that Spain is teetering on the edge with a budget deficit as high as it has been over the past 3 years at 10.2%, but they feel that the overriding uncertainty over the Italian elections mean that Spanish yields have been let off the hook somewhat recently. TS Securities analysts comments that peripheral sovereign spreads are steady ahead of the Italian election but the EU Commission downgraded its growth outlook for 2013 (another year of contraction).

Looking at the recent PMI readings, Jim Reid of Deutsche Bank notes that DB economists write that the flash numbers suggest that on average the PMI in the 'non-core' countries weakened on the month in both manufacturing and services by a greater extent than in the core countries. Sebastien Galy of SocGen writes, “Germany is continuing to do what it does best, namely the future of what Europe could be if it does go through its own decade of structural reform.” He notes that the divide between north and south is depressing as it suggests that Germany continues to adapt faster. Further, he adds that a proxy for Germany is typically Sweden and the latest indices from economic tendency to manufacturing also point to a global cyclical rebound.

Danske Bank analysts note a similar theme, commenting that the Italian election is greatly contributing to market nervousness, with investors seemingly pricing in a higher risk that Bersani and Minti might not be able to form a majority government as both Berlusconi and Grillo may have gained votes since the latest opinion polls were published in early February. Caroline Newhouse of BNP Paribas comments that the improvement in the German IFO results serve as a further indication that German economic growth is likely to recover this year as exports should benefit from an improvement in world demand and progressive resolution of the European sovereign debt crisis.

USD/JPY

Brown Brothers Harriman analysts note that USD/JPY has been in a range for the better part of three weeks now and local press reports are suggesting that Japanese exporters are reviewing their internal budget rates and are revising them from 75-80 to 85-90. Jim Reid of Deutsche Bank notes that PM Abe´s meeting with president Obama will be greatly watched by markets for any indications of talk on currency valuation.

TD Securities analysts comment that USD/JPY has continued to consolidate and the market is sitting long a lot of USDs that were bought after the G7/20 statements, but they write, “but the lack of upside traction in the market in response to what many interpreted as a “green light” for JPY selling is likely to begin weighing on the market sooner or later. We still rather think that, with a lot of bad news priced into the JPY here, near-term risks lie to the downside in USD/JPY (some of the key cross/JPY markets are trading heavily and will be a drag). Key support remains 92.20—recent lows and trend.”

Macro

Brown Brothers Harriman analysts feel that the North American market will put the finishing touches on what has been a generally constructive week for the US dollar. They note that ironically, the one notable currency that it slipped against however, has been the Yen. Jim Reid of Deutsche Bank notes that the S&P500 continued its decline (-0.63%) after posting its biggest one day fall since November on Wednesday. Indeed the move across the last two sessions has managed to pretty much erase February’s gains, but its performance is still better than other major indices including the Stoxx600, Shanghai Composite, Hang Seng, DAX and CAC40 all of which are trading at levels lower than where they started the month.

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