A glimmer of optimism returned to the markets yesterday in the aftermath of the “Merkozy” press conference which saw Italian 10 year bond yields finish below 6% for the first time since October this year, however it was to prove rather fleeting.

One of the factors that helped drive yields down was the decision to drop private sector involvement in any future bailouts, while the commitment to push for a treaty amendment in order to enforce budget discipline raised market expectations that we could well see a more robust ECB once EU leaders had shown their commitment to tackle the current crisis.

While Merkel said she would prefer all 27 EU members to ratify the changes, they could still go ahead with the 17 countries already in the euro. This treaty change could well have faced fewer obstacles to the 21st July agreement which proved so tortuous, due to the fact that Eurobonds were off the table.

Unfortunately for Merkel and Sarkozy they reckoned without ratings agency Standard and Poor’s who decided to put 15 of the 17 European nations on negative watch for a downgrade, including all the triple “A” ones of Germany, Finland, Holland, Austria and France. The agency cited the fractured governance response of all EU nations to the crisis as well as the slowdown in growth in the Eurozone.

S&P went on to say that the ratings could be lowered by up to one notch for Austria, Belgium, Finland, Germany, Netherlands, and Luxembourg and up to two notches for the others, including France, depending on the outcome of this week’s summit. The downgrade review is expected to be completed as soon as possible after the EU summit this Friday.

This action by Standard & Poors more or less kills the EFSF stone dead as it would mean that it would be unlikely to carry a triple “A” rating, especially if France is downgraded, which now seems increasingly likely.

The downgrade threat also makes it much more politically difficult for countries that have a large euro sceptic element like Finland who have also been more fiscally conservative.

Given this conservatism they probably have more to lose and could rather beg the question, why ratify a treaty change that could well precipitate a ratings downgrade.

It also seems likely to raise the political pressure in Germany on Angela Merkel with respect to the costs of closer integration with economically weaker European countries as their borrowing costs rise.

This it would seem is the price of admission towards closer integration, the question now being asked around Europe in the triple "A" countries could be whether it\'s a price worth paying?

Later this morning as if to emphasise S&P’s concerns about growth, the latest Eurozone GDP numbers for Q3 are due, with expectations of a rise of 0.2%, equating to a 1.4% rise year on year.

The Irish finance minister is also set to disclose the 2012 Irish budget, embarrassingly already seen by EU politicians which include €3.8bn more in austerity measures, some of which were revealed on Sunday night, including the raising of the VAT rate to 23%.

US Treasury Secretary Tim Geithner is set to meet ECB President Mario Draghi and Bundesbank President Jens Weidmann in Frankfurt, no doubt pleading with them to be more flexible on the monetary policy front, and then goes on to Berlin to meet German Finance Minister Wolfgang Schaeuble.

In Australia the RBA rounded off 2011 by cutting interest rates by 25 basis points for the second month in a row in reaction to the deteriorating global economic outlook and the situation in Europe.

EURUSD – the single currency one again tried to rally yesterday but failed to get above 1.3500 before sliding back in late US trading. The 1.3570 and the highs of the last two weeks remains the key level preventing further gains.
The next support level lies at 1.3340 trend line support from the 25th November lows at 1.3210. A break here potentially retargets the November lows.
The objective remains for a retest of the lows in October at 1.3150 on the way to the 1.3050 level, which is the 61.8% retracement level of the 1.1880/1.4940 up move. A break here would then target this year’s low at 1.2870.

GBPUSD – the pound continues to struggle to rally much beyond 1.5700 and this continues to weigh on the pound A break below 1.5620 could well open up the risk of a return move back towards the 1.5500 level.
Key up trend line support lies at 1.5450 from the May 2010 lows at 1.4230.
Only a move beyond last weeks high at 1.5780 is the main barrier to a move towards 1.5825. Any move above here could well extend towards 1.5900.

EURGBP – still in our broad range but with a pretty solid top forming now around the 0.8620 highs from last week, just below the much tougher resistance at the 0.8650/70 area and 55 week MA. A move above 0.8670 retargets a move towards 0.8730.
The single currency stubbornly refuses to close below the 200 week MA at 0.8565 and as such, short squeezes remain a concern.
Another key support is trend line support at 0.8385 from the October 2008 lows at 0.7695.

USDJPY – dips here continue to find steady buying interest above trend line support at 77.60 from the 75.30 post war lows.
The main target remains for a move towards trend line resistance at 79.00 from the 2007 highs at 124.15, on a break above the 78.30 level.
Only below 77.20/30 area would undermine this scenario, and risk a move lower that would see the next key support area around the 76.20/30 area, a break below of which opens up the lows at 75.30.