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Fundamental Morning Wrap: No Renaissance as Italian politics threatens to choke Europe

A look through this mornings institutional research shows that Europe is firmly in focus, with the fall out from the Italian elections taking center stage, with political deadlock, the resurgence of Berlusconi, again and the probability of renewed elections all weighing on risk sentiment.

EUR/USD

Westpac analysts start by noting that the Italian elections represent an important step in the deterioration of European politics. They note that all previously held ideas of Berlusconi being finished, again render conventional wisdom redundant, and Italy´s best hope is for Bersani to attempt to build a “Grand Coalition” to avoid gridlock. Geoffrey Yu and Gareth Barry of UBS note that the stalemate holds similarities with the Greek situation in May 2012, a fact that hasn´t escaped investors. They feel that EUR/USD could decline further, weighed down by Italian bonds and stocks.

Jane Foley of Rabobank adds to the theme, noting that early year optimism has been given a sharp wake up call following the Italian elections. Jim Reid of Deutsche Bank continues to highlight that Monti´s policies have acted almost as a benchmark for the Eurozone approval rating, and his dismal polling at 10% underline the mood of the Italian public. Danske Bank analyst are expecting an interim government to be installed before further elections take place. Kit Juckes of SocGen feels that 1.3000 will be the key level for EUR/USD and a move lower could see some real momentum develop.

GBP/USD

Geoffrey Yu and Gareth Barry of UBS note that while a lot of GBP selling was a knee jerk reaction to the UK downgrade, a significant amount could have come as part of a technicality as some funds are prohibited from holding less than AAA assets. Jim Reid of Deutsche Bank, and Kit Juckes of SocGen both note that GBP received a boost yesterday, following Eurozone insecurity, showing that Sterlings days as a safe haven currency are not over just quite yet.

Macro

Jim Reid of Deutsche Bank notes that Bernanke´s testimony today will be closely watched, however, he is not expecting him to express a meaningful change in viewpoint at this juncture due to lingering uncertainty and geo-political sensitivity over the issue of currency valuation.

NAB Bank focus on the Chinese miracle, and ask whether it is sustainable. They list a variety of factors ranging from population demographics, labour market conditions, production shifting offshore and exchange rate flexibility as reasons worthy of consideration for the years ahead.

Forex Flash: GBP gets pounded as asset managers sell – UBS

The downgrade of the UK last week has already triggered a response in GBP. On Monday the currency underperformed nearly all G10 currencies – even against the EUR and JPY, both of which had some unfavorable event risk to reckon with. According to Research Analyst Gareth Berry at UBS, “Even though structural deficiencies had already been expected for the UK economy and the pound for some time, the selling triggered on Friday points to some active divestment flow. Our FX Flow Monitor did show heavy GBP/USD selling by asset managers last week (third largest on record by this community), but the bulk of selling still took place on Friday.”
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Sequestration deadline looms as US political brinkmanship prevails

President Obama continues to warn of the potential cataclysmic economic impact from sweeping budget cuts that will trigger in just three days without a deal, as the United States may face more serious ramifications, culminating in prolonged fiscal debates in the months ahead. With such little time before the deadline, i.e. the $85 billion in reductions for this year, Obama and Republicans led by House Speaker John Boehner yesterday traded barbs at each other, doling blame for the extended impasse. The president and his Cabinet officers made a big to highlight the lost jobs, long lines at airports, delays at ports and cutbacks at popular national parks as motivation for pressuring their respective constituents.
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