Europe’s markets set to continue higher

Equity markets look set to continue their unerring move to new multi-year highs with both the DAX and S&P 500 edging ever closer to pre-crisis levels and their all-time highs set in 2007.

It appears that for now investors are prepared to set aside concerns about the underlying strength of the current recovery in economic activity and continue to rotate capital into equity markets, with the VIX trading at multi year lows.

Markets appear to be taking comfort from the continued improvement in US weekly jobless claims, along with signs of recovery in German economic data. Also helping sentiment on Friday was the announcement by the ECB that 278 banks would be repaying about €137bn of LTRO liquidity from the first round of loans made available by the ECB at the end of 2011.

These repayments have been taken as a positive by markets that Europe’s banks could well be in better shape than originally thought, however given that one of the other reasons for the LTRO was to create a trickle-down effect into the European economy, the larger than expected repayment suggests that there is little or no demand for the extra liquidity, raising concerns about the strength of any recovery in economic activity outside of Germany.

Furthermore the draining of this liquidity has helped push the euro to multi month highs, which is likely to heap further pressure on the more fragile peripheral economies. The apparent lack of concern from ECB policymakers with respect to this could well come back to haunt them in the coming months, especially if the current rise remains unchecked.

A reminder of the problems facing Europe’s banking system, if any were needed came in the form of weekend events at Italy’s oldest bank Monte De Paschi, currently embroiled in a derivatives scandal that could well overshadow the upcoming elections, as it threatens to drag in a number of key party political players, from the current frontrunner in the Italian polls.

This week could well see further evidence of the underlying recovery in the US labour market with the latest ADP and non-farms payrolls data for January, along with the first indication of US Q4 GDP, which is likely to have taken a hit from Hurricane Sandy, as well as the uncertainty as a result of the recent fiscal cliff negotiations.

With those tortuous negotiations still fresh in the memory attention could start to shift towards the forthcoming budget sequester where $1.2trn of spending cuts could well kick in on 1st March.

EURUSD – Friday’s break above 1.3400 has seen the euro test the 1.3485 level which is the 50% retracement of the 1.4940/1.2045 down move. Just above that we have the 200 week MA level at 1.3500. Above 1.3500 targets 1.3835, the 61.8% retracement level of the same move. Pullbacks should find support at 1.3400, while below that we have the 1.3250 level the January lows. The long term support line from the 1.2045 lows now comes in at 1.3070 which remains the key level on the downside.

GBPUSD – last week’s break below 1.5815 now opens up the possibility of a test towards 1.5680 the 61.8% retracement of the 1.5270/1.6380 up move. There is also long term trend line support at 1.5630 from the 2009 lows at 1.3500. The 200 day MA at 1.5910 should now act as resistance.

EURGBP – last weeks break above 0.8420 saw the euro run into resistance at the 200 week MA at 0.8540, just short of the 0.8576, 61.8% retracement level of the down move from 0.9085 to the lows at 0.7755. Having acted as a top for so long the 0.8425 level should now act as support on any pullbacks. Long term trend line support at 0.8110 comes in from the 0.7755 lows.

USDJPY – another new high last week at 91.20 brings the US dollar close to the 94.00 level. We continue to remain extremely overbought which makes the US dollar susceptible to sharp pullback. Key support remains all the way back at the 87.50 level.