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Volatility To Pick up Into Final Session of Week As US Data Digested

We were off the desk on Thursday and not a lot has happened in that time, with the markets locked in some consolidation ahead of their next moves. While risk sentiment has certainly mounted a recovery over the past several days, we continue to warn that any additional gains in these risk correlated assets should prove fleeting in favor of a resumption of flight to safety trade. While Eurozone officials have been stepping up efforts to provide a more clear resolution to the current crisis, there is still a good deal of work that needs to get done before any results are seen, and this will likely take a very long time to play out. As such, the preferred strategy is to look to be selling the Euro into additional rallies towards 1.4000, while also taking advantage of the break back above parity in Aussie and looking to fade any additional strength towards 1.0500.

There have been very few developments over the past 24 hours but the most significant is not risk supportive and could start to weigh more heavily on sentiment into the weekend. S&P’s downgrade of Spain’s ratings to AA- from AA with a negative outlook, follows a similar ratings cut by Fitch in the previous week, and once again highlights the difficult path ahead for Eurozone recovery. Although citing some signs of resilience in the local economy in 2011, a combination of heightened risks to growth prospects, tighter fiscal conditions, elevated private sector debt, and a slowdown in the country’s trading partners, were all seen factoring into the downgrade. S&P went on to warn that Spain’s ratings could be lowered yet again if the economy continues to show signs of deterioration in 2012.

Moving on, there has been a lot of talk that the best option for Greece is to default, and suggestions that European investors should be required to take haircuts of between 50-60% has not helped to encourage the recent risk rally. Also in the headlines are comments from CBI director general Cridland who says that proposed EU financial regulation will likely have a negative impact on the UK prospects for recovery and growth. This follows some equally concerning Telegraph story from Thursday which talked of a potential UK downgrade. Markets have been fairly quiet into North America, but higher than expected Eurozone CPI has kept the Euro propped for now. Volatility should pick up into the US, with retail sales, Michigan confidence and business inventories are set for release.