The euro’s ability to defend bad news in Europe has been remarkable and its gains have reflected a speculative market that has been extremely short.

As we are light on headline data today the markets will have to observe the outcome of the somewhat positive Spanish and French debt auctions while keeping one eye on Greek debt talks with private investors.

But for yet another failure of talks in Greece the EUR should continue on a positive footing.

How long this will last is uncertain, particularly given the dangers ahead but at a time when investors have become progressively more bearish on the euro it may just extend its bounce over the short term.

One country to watch is Portugal whose bonds have underperformed recently as markets speculate that it could be the next contender for any debt note.

Back to the UK and Retail sales have come been announced close to median forecasts of +0.6% m/m and +2.6y/y.

Sales have improved in December but the improvement is likely to be short-lived, suggesting any support to the Pound will be brief.

Sterling has underperformed even against the firmer EUR of late but this is supporting better levels for the market to take long positions versus EUR.

This explains the move in relative European/US interest rate differentials, which has been linked with the move in EUR/GBP.

Overall Sterling could outperform EUR over coming months to around 0.80, with the former continuing to benefit from the simple fact that it is not in the Eurozone and has therefore acquired a quasi safe haven status.

Bank of America and Morgan Stanley’s results were better than expected.

Commerzbank shares rose 15% after it said it would be able to increase its capital without government help. Also in Frankfurt, Deutsche Bank rose 8%.

In London, Barclays shares rose 10% while Lloyds and RBS were both up 9%.

In Paris, Societe Generale rose 13%, Credit Agricole rose 9% and BNP Paribas gained 8%.

The soaring bank shares helped Europe’s benchmark indexes to strong closes, with the FTSE 100 ending up 0.7% at 5,741 points, its highest closing level since the start of August.

The Cac 40 in Paris closed up 2% while the Dax in Frankfurt gained 1%.

Some of the gains in banking shares were sparked by a report from Morgan Stanley, which said that the European Central Bank was flooding the eurozone banking system with even more cheap loans than had previously been thought.

After markets closed last night, Standard and Poor’s (S&P)  the credit rating agency dealt a severe blow to the European bailout fund by downgrading its AAA status to AA+.

Following the announcement, EU officials attempted to reassure markets that the funds will not change is ambitions to lend billions of Euros to struggling Eurozone states.

Proving how out of touch euro technocrats are the EFSF chief Klaus Regling claimed “The downgrade to AA+ by only one credit agency will not reduce EFSF’s lending capacity of €440 billion”.

This latest downgrade will increase pressure on Eurozone officials and German government to boost their contribution to the European Stability Mechanism which only becomes active in July.

Interestingly the euro has rallied so far following the announcement and currently sits at 1.2021 against Sterling and up against the Greenback at 1.2790.

This morning in the UK we had the latest CPI reading which indicated a 4.2% year on year according to the Office for National Statistics.

This is further fall following last months 4.8% figure and eases inflationary pressure on the Bank of England as it creeps lower towards the 2% target level.

This is the biggest year on year decline since April 2009, which was attributed to discounts on petrol gas and clothing according to the ONS.

The US re-opens today following its Bank Holiday for Martin Luther King day yesterday.

They start their week with Empire manufacturing data which assesses business conditions and expectations of manufacturing executives specifically in New York.

This is followed by a Canadian Interest rate decision where we are expecting them to maintain interest rates at 1.0%.

A new shockwave filtered through the markets on Friday as the credit agency Standard & Poors (S&P)- downgraded France, stripping them of its prized AAA rating.

S&P said “Europe’s austerity and budget discipline alone were not sufficient to fight the debt crisis and may become self defeating”.

Alongside France, S&P cut the rating of Italy, Spain, Cyprus, Portugal, Austria, Slovakia, Slovenia and Malta though it was expected that these countries would have their ratings lowered.

Overall, the picture isn’t looking good for Europe and with further downgrades likely over the next few months, it will be important to see how the ECB reacts in keeping this ongoing debt crisis under control.

The main winner from this continues to be the US Dollar with further gains against most currencies likely as investors pile more money into the global reserve currency.

For as long as the Greenback keeps this status, it will remain the market leader in these testing times as Europe sits on a knife edge between growth and recession.

There is very little data out today with the only comment of note coming from a speech by ECB President Mario Draghi due at 6pm UK Time.

It is likely he will focus on the downgrade on France and how the ECB will look to repair the damage it has caused.

The wise money markets continue to be driven almost exclusively by extreme changes in sentiment on a day to day basis.

Both countries we able to place the bonds at considerably lower rates than in recent auctions lifting sentiment and the euro throughout yesterday and into this mornings trading.

Worryingly data just out showed Spanish Banks borrowing almost €140bn from the ECB in December, almost the record high set back in July 2011 and this tugged sentiment back in the negative direction.

Both central bank decisions were tame affairs, neither the ECB nor BOE changed rates or announced any change to existing QE programs.

For the Bank of England it seems to be a very much wait and see approach before they announce further asset purchases.

Mario Draghi and the ECB can be pleased with the results so far from the LTRO in December.

Confidence seems to be improving in the European banking system because investors now feel the ECB stands behind the banks, and this is translating into lower yields for European Government debt.

The positive US data flow of recent weeks came to a halt yesterday afternoon, with retails sales figures lower than estimates.

This afternoon’s confidence survey will be very interesting to watch to gauge the state of the consumer given such weak retail sale figures and increasing jobless claims this week.

Looking towards next week there is a huge amount of Chinese data to digest first thing Monday.

Positive Chinese data is generally seen as bullish for the world economy, and hence US negative, so the release will probably set the tone for sentiment for the early part on the week.

Europe will remain under the spot light over the next couple of days with the European Central Bank (ECB) meeting today, alongside debt auctions in Spain and Italy.

Reports that Fitch ratings are unlikely to downgrade France’s ratings this year has provided a welcome boost to Eurozone confidence.

However Greece could yet spoil the party given the continuing dialogue with the Troika to decide the second bailout package for the country.

Political resistance within Greece suggests that more austerity may not be easy to execute.

For the time being there are ongoing questions about the degree of write-downs that Greek debt will endure.

In spite of these issues it looks like investors are becoming more immune to events in the Eurozone. While we still have high bond yields for Italy and other euro sovereigns it seems that risk appetite has improved.

One feature that is providing support to sentiment is the positive news out of the US.

Even though the Q4 earnings season has not started particularly well, data releases look rather more positive.

Last week’s US December jobs report continued to filter through positives to the market and we have also seen a pick up in small business confidence and a rise in consumer credit.

These recent improvements in economic data snaps highlight the gradual recovery process underway in the US and the growing divergence with the eurozone economy.

This supports the view of the US Dollar out performing the euro in the short to medium term.

The volatility that ended 2011 has yet to return the markets with Sterling, Euro and the US Dollar all remaining relatively stable against each other.

Both the Bank of England and European Central Bank are expected to keep rates unchanged at 0.5% and 1% respectively, but the press conference with the newly appointed chief of the ECB, Mario Draghi will be closely monitored.

Any comments about the economic conditions and the ongoing debt crisis in the Eurozone will have a large impact on where the markets move next so no pressure Mr Draghi!

More pressure was piled on the sovereign debt predicament a number of European countries continue to be on many of the credit agencies “negative watch”.

Fitch announced that it is likely to slash Italy’s credit rating at the end of January, which will make it even harder and more costly for the struggling nation to borrow funds.

Spain, Belgium, Ireland, Slovenia and Cyprus are also on the list as the credit agencies remain eagle eyed on how conditions change.

With much of the focus on the Europe and its single currency, expect the US Dollar and commodity currencies like the Canadian, Australian and New Zealand Dollars to remain strong as investors look for safer havens to keep their money during these worrying times.

Further euro weakness could also be on the cards if negative comments are realised on Thursday.

A fresh wave of negative sentiment swept the wise money markets caused by doubts over euro banks’ capital raising plans and Hungary’s solvency.

This led to investors selling shares in the continent’s major lenders. Italy’s biggest bank, UniCredit saw its share price fall by over 17% after it announced a heavily discounted rights issue, which valued stock at less than a third of it current price.

Over in Hungary, the yield on 10 year bonds soared to over 10% after the government failed to find enough buyers for the 45bn forints (£116 million) of sovereign bonds it was trying to sell. This combination of weakness in the Eurozone led to the single currency dropping to 15 month lows against Sterling.

This weakness in Europe was countered by positive data from both the UK and US.

The UK’s biggest sector, services ended last year on a high while America’s efforts to improve their jobs market showed signs of progress.

The US private sector added 325,000 new jobs in December and the non-farm payrolls are due out today with a rise of 150,000 jobs expected.

Overall, it has been a simple week for the markets with the euro continuing to be weak while the US Dollar remains the strongest of all as investors put their money into the global reserve currency.

Festive cheer in the money market seem to be running out already as we move towards the end of the first trading week of 2012.

The euro was under pressure for most of yesterday as risk was dumped and the US Dollar strengthened.

The theme is continuing this morning as the single currency continues to be sold; European banks continue to make headlines for the wrong reasons as they park newly created ECB cash back at the central bank rather than lending or investing it in the real economy.

Retail gloom continues to hang over the UK with many of the retailers reporting crucial Christmas figures this week.

Next shares were pummelled after they reported disappointing sales over the festive period and set a gloomy tone as we wait for results from rivals M&S.

John Lewis were a ray of light in the gloom, posting impressive sales growth compared to last year, but most if not all retailers are suggesting that economic conditions remain a real concern and are expecting a challenging year.

The Pound has opened the year in much the same way as it finished the last, namely taking a back seat to the Euro and Dollar with economic fundamentals remain less of a driver than politics.

The wise money is hoping for a clear sign of the economic picture on Friday from the Non-farm payrolls, either showing the recovery continuing or a worsening picture and the prospect of further QE this year.

More likely is that the number shows the US economy to the chugging along slowly, leaving both the Fed and the markets disappointed.

European stock markets started the year in optimistic style with gains led by the German DAX index after the release of better than expected levels for eurozone purchasing managers indices (PMI).

The combined eurozone data however, remained at a weak level, contracting for a fifth month in a row, and remains constant with eurozone recession.

One would not expect this equity rally to continue over the rest of this week, as risk aversion is set to play out alongside the on-going Eurozone debt and global growth worries.

Indeed, both French and German leaders in their new year messages talked about the risks ahead.

A summit between Germany’s Merkel and France’s Sarkozy is planned for January 9th ahead of an EU Finance Ministers summit on January 23rd. It is unlikely that there will be any major policy decisions in Europe before then.

In the meantime, German press reports suggest Germany is pushing for an even bigger write down of Greek debt than previously approved will only add to risk aversion over the short term.

The report in the Greek press highlighted the prospect of a 75% write down of Greek debt a far cry from the 20% proposed some months ago.

Eurozone markets continue to be troubled by the scenario of credit downgrades by major ratings agencies at a time when many countries have to issue hefty amounts of debt to suit their funding needs.

Against this background the EUR is set to remain under pressure, with a notable drop below EUR/JPY 100, its lowest level in over a decade registered. Reflecting the deterioration in sentiment for the currency, EUR speculative position hit an all-time low at the end of last year. This is unlikely to reverse quickly, with sentiment set to deteriorate further over coming weeks and months as the EUR slides further.