Europe to slip back ahead of Italy vote and ECB, as US shutdown continues

Yesterday’s rebound in US and European markets can more than likely be explained away by the belief that politicians in the US will eventually come to their senses and agree a deal after a few days of posturing and a bit of name calling.

Today’s European open however looks likely to be tempered by a dose of realism as investors ponder a prolonged shutdown, an uncertain Italy vote and the ECB rate meeting.

Of course the belief that politicians will do the right thing presupposes that both sides earnestly want to agree a deal, but given the tone of their behaviour one has to ask if that is in fact the case, and a speedy resolution may not materialise.

Given the political distance between the two party’s base line positions any deal will have to bridge a very large political divide. How will the various protagonists square that particular circle given the tone of some of the recent rhetoric?

For all the markets optimism right now that the politicians will do the right thing, the worry is that this deadlock could drag on and become inextricably intertwined with the debt ceiling discussions, and if that becomes the case then market nerves could well start to jangle again.

We already know that we won’t be getting a sight of the latest US employment report on Friday, which makes today’s September ADP employment report an important guide to the health of the US labour market. Expectations are for a figure of 176k, unchanged from August.

On the other side of the coin the only thing it adds to the taper debate is that it probably moves the timeline of any Fed taper into next year, given that any prolonged shutdown will do significant damage to the US economy, and this could be another reason for the relative buoyancy of stock markets at the moment.

In Europe the political situation is no less bizarre after Berlusconi’s weekend decision to pull his PDL ministers out of the coalition government.

If today’s confidence vote is held as expected, there had been a concern that Italian PM Enrico Letta wouldn’t be able to get the votes needed to continue in government. That perception changed yesterday afternoon when in signs even his own party is tiring of his antics, Berlusconi’s party secretary Angelino Alfano stated that the party should be supporting Mr Letta.

One can only imagine what Berlusconi thought of that, and hopefully Mr Alfano doesn’t find a horses head in his bed, but if enough of Berlusconi’s party were to articulate a similar view when voting then the former PM could well be left out in the cold.

As it is Berlusconi has insisted that the PDL must vote against Letta in any vote in defiance of the nearly 30-40 MP’s who it has been suggested have a different view. It’s a high risk strategy by Berlusconi which could backfire on him badly.

Given the political turmoil in Italy and yesterday’s rise in the unemployment rate the focus shifts back to the European Central Bank rate meeting which takes place today in Paris.

There isn’t an expectation of any change in monetary policy, but given the strength of the euro Mr Draghi can be expected to face some questions about the damage the strength of the currency is doing to the weaker European economies. It is therefore highly likely he will seek to covertly talk the currency lower, while at the same time saying that the ECB does not target the exchange rate.

The weak recovery in Europe is also be expected to be a key topic along with the continued fractured nature of the banking system, with business lending remaining weak. In this context he is likely to be asked about another LTRO.

In the UK yesterday’s manufacturing PMI for September came in slightly below expectations at 56.7, but the employment component showed a bigger than expected rise, which bodes well for future falls in the unemployment rates. Today’s construction PMI for September is expected to similarly positive with a figure of 59.5, up from 59.1 in August.

EURUSD – we continue to remain capped just above the 1.3570 area and this level continues to remain the main obstacle to a move towards the 1.3710 area. A break below the 1.3450/60 area which acted as support last week would complete a double/triple top formation and signal a move towards the 1.3320/30 level.

GBPUSD – this week’s break above the 1.6160/70 area has seen the pound push up towards the 1.6300 area, falling just short at 1.6260. We have trend line resistance at 1.6330 from the 2009 highs at 1.7045 as well as the highs this year at 1.6370 which are significant resistance. The 1.5980 area remains the key support area on any pullback. The risk is that a sustained break below 1.5980 could suggest a move towards the lows last week at 1.5880 and the medium up trend support now comes in at 1.5820 from the 1.4815 lows.

EURGBP – downward pressure continues to build while below 0.8410 and brings the prospect of a move towards the 0.8280 area, the 50% retracement of the 0.7755/0.8815 up move. Downtrend resistance from the upside can be found at 0.8400 while above that the 0.8470 area remains a key resistance and we need to see a move above the 0.8500 area to retarget the 200 day MA.

USDJPY – we saw the US dollar briefly dip below the trend line support at 97.65 from the June lows at 93.85, as well as the daily Ichimoku cloud support of the past two weeks. Only a move below this trend line and 97.50 suggests further losses towards the 94.00 area. We need to see a move above the highs two weeks ago at 100.60 to retarget the 103.70 area.

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