After seven consecutive down days European markets staged a bit of a rebound yesterday led by the banking sector, but it was a pretty feeble affair given the declines that preceded it.

The rally in bank shares was prompted by unconfirmed reports out of Germany that the ECB could buy bank stocks as part of a new QE program.  Putting to one side the small problem of whether such a course of action would even be within its mandate, it would be a pretty radical departure for a central bank that has usually had to be dragged kicking and screaming to do anything particularly contentious.

While yesterday’s rally was welcome most of the markets attention yesterday was on Fed Chief Janet Yellen’s semi-annual testimony to Congress, where investors were looking for clues as to the direction of the Fed’s thinking in light of recent market volatility.

The tone of the text appeared to divide opinion with respect to its hawkishness or dovishness, but however it was interpreted it was fairly clear that the Federal Reserve is concerned that the current market volatility could blow the US economy off course, even if she went to great lengths to remain fairly upbeat on the US economy.

Her comments that “financial conditions in the United States have become less supportive of growth” were a nod to the slowdown in China, the appreciation of the US dollar, and weaker oil prices. She went on to assert that “if the economy were to disappoint, a lower path of the federal funds rate would be appropriate. We are committed to our dual objectives.”

On the subject of negative rates she was non-committal but suggested that there could be legal implications preventing their use, notwithstanding their use might cause some practical problems in US markets.

In cricketing parlance she played a fairly straight bat in terms of not committing one way or the other, and while she didn’t rule out the prospect of further rate rises, it appears pretty obvious that the Federal Reserve isn’t going to be hiking rates again anytime soon.

Ms Yellen will also be speaking again later today, though it’s quite likely that this second day of testimony is unlikely to add much more than yesterday’s comments.

While US stocks initially tried to rally they slipped back into the close, alongside a decline in oil prices, and this is likely to translate into a slightly weaker European open this morning, particularly since Asia markets failed to gain any traction at all, though the Hang Seng was merely playing catch up after its Chinese New Year break.

In a day fairly light of data the main focus is likely to be back on the banks to see whether they can sustain yesterday’s rebound, as well as oil prices with US prices back flirting near their lows of last month. Brent prices on the other hand appear to be holding up a little better as speculation swirls about an agreement on production cuts, which while remaining unlikely, appear to be helping to support the price at the margins, along with a slightly weaker US dollar.

Yesterday’s economic data from France, Italy and the UK followed on from some disappointing and industrial production data from Germany on Tuesday, which pretty much confirmed the manufacturing sector across the whole of Europe had a pretty rotten end to 2015, in line with the US and China.

It also puts the onus back on speculation on the ECB’s next move but it is becoming increasingly clear that the leaning towards negative rates is starting to run out of road, given the potential effects on the overall resilience of European banks.

EURUSD – dropped back to 1.1160 yesterday but the decline was short lived and as such a move towards the 1.1400 area remains on the table. Upward momentum should remain intact while above the 200 day MA at 1.1050 and while we remain above this level the prospect for further gains towards 1.1400 remains. A move back below 1.1040 could well see a revisit of the 1.0970 level.

GBPUSD – the pound has struggled to rebound and hasn’t been able to retest the highs last week at 1.4665, but is finding support around the 1.4440 area as well as the1.4350 level. While above the 1.4220/30 area the bias remains towards the upside and a return to the recent highs and on towards 1.4800.

EURGBP – has pulled back from the 0.7860 area and could slide back to the 0.7690 area in the short term but while we remain above this level then the risk remains for a run towards the 200 week MA at 0.7945.

USDJPY – continues to look soft breaking below 114.00 as it looks to move closer towards the 110.00 area. If we close the week below 116.00 which acted as the base for all of 2015 then we could well see further US dollar weakness in the coming weeks towards 110.00, and even 106.00. We need to see a recovery back through 118.20 to stabilise.

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