Equity markets rally set to continue

Rising equity markets, falling peripheral bond yields and CDS spreads has seen a surrealist calm return to financial markets since the beginning of the year, or as ECB President Draghi called it last week, normalisation and positive contagion.

Investors appear to be taking confidence from some of the more positive earnings reports seen in the past week that despite various concerns about growth companies, with some exceptions, appear to be doing better than expected.

Whether this week’s earnings reports from retailers, and in particular US banks, reinforce the current levels of optimism remains to be seen, however forward guidance is likely to be a significantly more closely monitored metric than usual.

Equity markets, in particular have pushed to their highest levels in over 5 years pre-Lehman crisis and broken some key technical levels in the process, sending the bears scurrying back to their caves to lick their wounds.

The VIX has also hit 5 year lows as investors worry less about guarding against a market sell-off and slowly dip their toes back into the market, raising concerns about increased levels of investor complacency.

The only one thing wrong with this picture is that the current market rally is set against some pretty dire fundamentals, not only in Europe, where unemployment is at record levels, but also in the UK as well, as data showed last week that the UK economy could well have contracted in Q4.

This week’s UK inflation data isn’t likely to paint a particular rosy picture either, further squeezing consumers as incomes continue to lag behind price rises.

Unemployment in Europe continues to push higher, especially amongst the younger population, where it shows no sign of abating creating a potentially difficult problem for policymakers as they start looking at policies to kick start growth and get people back into work.

Today’s Eurozone November industrial production data is expected to reinforce the point with a 3.1% decline year on year expected, though it’s not expected to be on the scale of the annualised decline in the Italian Industrial production measure which is expected to show a decline of 6% year on year.

Even in the US the problems of the debt ceiling and political paralysis loom large as politicians continue their partisan bickering, while the platinum coin option appears to have been kicked into touch by the Federal Reserve and US Treasury.

EURUSD – Friday’s break above 1.3300 now opens up the possibility of the test towards the 1.3500 level which is the 200 week MA as well as the 50% retracement of the 1.4940/1.2045 down move. Expect support to come in at 1.3300 now on any pullbacks, and 1.3170.
The long term support line from the 1.2045 lows now at 1.3000 remains the key level on the downside while a move below 1.2950 targets the 100 day MA at 1.2935 and below that the 200 day MA at 1.2780.

GBPUSD – continues to range trade between resistance near the 1.6180 level and support just above 1.6000. To retarget the resistance at 1.6310 the cable needs to get above 1.6180. A break below the 1.6000 level is needed to target major trend line support now at 1.5965 from the 1.5270 lows, the 200 day MA at 1.5900, as well as 1.5660.

EURGBP – having broken above the December highs at 0.8225 and 0.8265, the risk now shifts towards a test of the 0.8420 level, which is a 50% retracement of the down move from 0.9085 to the lows at 0.7755. Pullbacks are likely to find support at 0.8225 and 0.8170.
The long term trend line support at 0.8090 from the 0.7755 lows remains a key level, a break of which could well signal further losses towards the November lows at 0.7960.

USDJPY – the 90.00 level is slowly coming into view, after last week’s 89.45 high.
Ultimately the current rebound could well head to the 94.00 level over the coming weeks, however current momentum is looking rather stretched. Pullbacks could well see support at the 88.40 area and the 87.50 level.