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Euro Strength at Risk Ahead of Stress Tests, Dow Jones Reversal

Euro Strength at Risk Ahead of Stress Tests, Dow Jones Reversal

2010-07-16 21:16:00
David Rodriguez, Head of Product
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A relatively empty week of economic event risk promises little in the way of foreseeable currency volatility, but a noteworthy exception comes on the results of European bank stress tests due Friday. The successful auction of Spanish government bonds eased fears on sovereign solvency, but doubts remain on the creditworthiness of private regional banks. Recent European Central Bank data shows that Spanish banks are particularly dependent on central bank funding, and market reaction to stress test results may be significant.

In the best case scenario, the reports will show that there are no broad funding deficiencies across private sector banks. In the worst case, the stress tests will reveal that corporations will continue to depend heavily on ECB funding through the foreseeable future. It is admittedly difficult to handicap the outcome and much less predict how the Euro may react to whatever the reports show. As such, it will be important to monitor the event itself and whether or not it forces any substantive shift in financial market sentiment. Given the Euro’s recent gains on a broad improvement in regional optimism, risks may very well favor the downside ahead of release.

Traders should otherwise monitor any and all developments surrounding global financial markets and implications for the risk-sensitive Euro/US Dollar currency pair. A 3+ percent drop in the S&P 500 on Friday led to a noteworthy correction in the EURUSD, and a continued reversal would almost certainly put recent Euro strength at risk. With the Dow Jones Industrials Average just a stone’s throw from the psychologically significant 10,000 mark, a significant break lower could lead to contagion across broader financial markets. - DR

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