Europe’s markets set for pause after sharp sell-off

After the gains of the last few weeks a sharp selloff was always going to draw the inevitable questions as to whether or not this move was simply a pause for breath, or a precursor to a steeper decline in equity markets and the single currency.

It is also inevitable that opinion will likely be split about market direction from here, however early indications suggest we could be in for a bit of a correction, even if we see higher markets later on in the year.

The extent of yesterday’s declines seen across markets suggests that the time may be right for a bit of consolidation, and with the political situation in Spain unlikely to be resolved quickly, investor uncertainty is likely to keep a floor under Spanish yields, and keep a lid on equity markets.

When combined with the on-going uncertainty building surrounding the Italian election it seems likely that we could well be emerging from the sweet spot of the last few weeks.

Today’s European economic data releases aren’t expected to be particularly positive with the latest January services PMI readings for Europe, Italy and Spain only expected to improve slightly. The Eurozone measure is expected to come in at 48.3, while the Italian and Spain measures are expected to improve slightly to 45.9 and 44.7.

The only bright spot is likely to be the German numbers which are expected to come in at 55.3, while the French numbers are expected to come in at 43.6, highlighting the continued divergence of the two largest European economies away from each other, in a worryingly new development in the European crisis.

The latest European retail sales data are also expected to disappoint which wouldn’t be a surprise given the shocking German numbers last week, with expectations of a 1.4% decline year on year, and the fourth monthly decline in the last five months.

In the UK expectations about services PMI are also expected to be low after December’s surprise fall below 50 to 48.9. The January figure is expected to recover but is still expected to come in below the 50 level. If we do get a second successive monthly reading below 50 it will be the first time we’ve seen this since May 2009, after the services sector had been in contraction for 12 months in a row, as the economy imploded in the face of the banking crisis in 2008.

EURUSD – what a difference a day makes, however despite pushing back below the 200 week MA yesterday we need to close below it on a weekly basis to suggest a deeper pullback. Maybe yesterday’s bearish engulfing pattern is the early indication of a pullback.
First stop is likely to be the 1.3400 level, 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 1.3110 which remains the key level on the downside.

GBPUSD – the inability to break below the key support remaining at 1.5680 the 61.8% retracement of the 1.5270/1.6380 up move, keeps the risk of move back towards 1.5910 on the table. There is also long term trend line support at 1.5630 from the 2009 lows at 1.3500, a break of which opens up the 2 year range lows at 1.5270.
The pound needs to close back beyond the 200 day MA at 1.5910 to stabilise and diminish the downside risk.

EURGBP – yesterday also saw all Friday’s gains wiped out with a dark cloud cover daily reversal. The 200 week MA and 0.8525 level should now act as support on any pullbacks, with only a push below re-targeting the 0.8425 area. Long term trend line support at 0.8115 comes in from the 0.7755 lows.

USDJPY – a bit of a pullback yesterday but we still got another new high at 93.20 as the US dollar closes in on the 94.00 level, which is 38.2% retracement of the down move from the 2007 highs at 124.15 to 75.30. We also have resistance at 95.00 which is the 2010 highs.
Only below the 90.30 level argues for a deeper correction towards key support at 87.50.