More falls for EU Indices as debt talks hits crunch time

Stock Indices around Europe suffered yet more falls on Friday as investors sold out of risky asset classes ahead of pivotal weekend of negotiations on Capitol Hill to agree on deficit cuts and raise the US debt ceiling before the August 2 deadline. A move by rating agency Moody’s to place Spain on review for a ratings downgrade also weighed on sentiment on Friday.

Investors are getting nervous over the continued deadlock seen in Washington between the Republicans and the Democrats. We are approaching crunch time now and investors need to see progress being made in the next few days or we could face the previously unthinkable event of the US suffering a default. If we don’t see in-roads made between the two parties in the US over the weekend, both stocks and forex markets could be set for a volatile opening on Sunday evening and Monday morning.

The fact that Republican House Speaker John Boehner’s bill failed to garner up enough support from members of his own party, before the Democrats had a chance to even vote against the bill or Obama veto it, is equally troubling. How can we expect the Republican Party to agree a compromise with the Democratic Party on a bipartisan plan when they can’t even agree amongst themselves about what measures must be incorporated into a deficit plan before raising the debt ceiling.

The move by Moody’s to place Spain on warning for a credit ratings downgrade is also weighing on market sentiment today. The move sent credit default swaps on 5 yr Spanish debt higher by 25 basis points, whilst the Spanish Ibex Index was the worst performing Index in Europe on the day, down 1.2%. the move by Moody’s is not a huge surprise, but it taps into the existing fragility of investor sentiment on wider contagion of sovereign debt in the eurozone and as such, has contributed to the existing negative theme to trading today.

The reaction in the markets to both the US and eurozone debt issues has been a continuation of the risk off theme that has dominated price action for much of the week. The FTSE 100 fell by around 0.5%, having opened 1% lower, whilst similar bearish moves were seen the DAX,CAC and Italian MIB. Losses in the DAX were however slowed by a much stronger reading than expected in German retail sales. Retail Sales grew by 6.3% when a much slower growth of 1.6% was expected after a 2.8% slump in May.

In the UK, it is the typical risky asset classes that are seeing weakness. The oil, mining, banks and insurance firms are all weighing on the FTSE100 as a result, trading lower by between 0.7% and 1.2% on the day. The FTSE 100 has however continued to find support around the 5800 level, which has prevented falls over the last few days from escalating. Should the UK Index break this, more support could be found at the 5740 level.