Could Bernanke Help The EUR/USD?

Italian equities drop -4% on open, but Euro holds 1.3000 for now
Italian Bill auction sees yields rise by 50bp
Nikkei -2.26% Europe -2.20%
Oil $92.45/bbl
Gold $1597/oz.

Europe and Asia:
NZD RBNZ 2-Year Inflation Expectation 2.2% vs. 2.3%

North America:
USD House Price Index 9:00
USD Bernanke Testifies at Senate 10:00
USD Consumer Confidence 10:00
USD New Home Sales 10:00

One day after the shocking Italian election that strongly rejected the austerity policies imposed on Italy by Brussels, capital markets in Europe were sharply lower, but the EUR/USD survived several selloffs to remain above the key 1.3000 level for now. Italian equities dropped by nearly -5% on the open of European trade and credit markets saw yields spike as investors feared that results of the election have rendered the country ungovernable.

The status quo favorite Pier Luigi Bersani won the lower house by less than a half a point while Silvio Berlusconi, the former premier came in a surprisingly strong second winning a blocking minority in the Senate. In its first national contest, the protest candidate Beppe Grillo received more than 25 percent support making him a key player in the new Italian government.

The three way split has effectively created a stalemate and over the next several days Mr. Bersani will most likely attempt to create a coalition government but few experts expect him to succeed. Furthermore, any future Italian government is unlikely to pursue the stringent austerity agenda imposed by Mr. Monti as the economic toll of his policies has created a clear rebellion amongst the voters.

Italy now stands as ground zero for the EZ sovereign debt crisis which could deepen over the next several weeks if the uncertainty continues to weigh on the capital markets. Today’s Italian bill auction already saw the effects of the election as yields spiked by more than 50 basis points rising to 1.237% from 0.731% the month prior. This was the highest yield since October showing that the cost of financing for Italy may rise significantly this year adding further downward pressure to an already weakened economy.

Despite the ongoing turmoil and tribulations, the EUR/USD managed to stabilize in morning European dealing as sovereign fund demand and bargain hunting from Middle East kept the pair above the key 1.3000 level. Speculators may be also positioning themselves ahead of the key testimony by Fed Chief Ben Bernanke who will make his semi-annual appearance in front of Congress.

Although markets have speculated that the Fed will begin to curtail its QE buying program sometime in the foreseeable future which would be positive for the dollar, we doubt that Dr. Bernanke will communicate that message today. Dr. Bernanke is a well known dove on the FOMC and given the fresh credit risks out of Europe we believe his impulse will be to remain accommodative for now.

Therefore his testimony may provide a modicum of relief for the EUR/USD and the pair could rally above the 1.3100 level on some short covering flows. However, once the attention turns back to Europe, the intractable stalemate in Italy could revive risk aversion flows as the week proceeds and leave EUR/USD vulnerable to another test of the 1.3000 level.