Catalan Independence Declaration: What To Expect Of EUR/USD?

The focus of the deepening clash between Catalan separatists and Spanish authorities has shifted to Catalan President Carles Puigdemont's key address to the regional parliament. Many observers expect the President to make a declaration of independence.

Catalan government is isolated in its struggle

• European leaders are either supporting the Spanish government or staying neutral
• German Chancellor Angela Merkel also "affirmed her backing for the unity of Spain" in a phone call with Mr Rajoy
• King Felipe sided with Madrid and criticized referendum. Instead, the King should have called for national unity
• So far, the EU has stayed on the sidelines

Catalan government has won public sympathy

"One cannot convince people to stay within a country by beating them into silence". The actions of Spanish police, Madrid's hardline stance and King Felipe's one-sided condemnation of the referendum created the perception of oppressed people fighting for freedom, boosted the 'anti-establishment' sentiment and has won public sympathy for the Catalan government.

It is being reported across the wires that Madrid can use powers under its constitution to dissolve the Catalan parliament and call a regional election or after the declaration of independence, it could invoke article 155 of the Spanish constitution, which would allow the Madrid government to step in and take control of Catalonia. These moves are risky as they could lead to further clashes... and shall only end up strengthening the Catalan government's appeal as the one fighting against an oppressive regime. The rise in anti establishment sentiment would then be felt across the Eurozone.

The Spanish prime minister has stressed that there could be no negotiations whatsoever until Puigdemont’s government stepped back from the brink. Thus, odds are high that Madrid may invoke article 155 risky if the Catalan government declares independence.

• Read - EUR/USD Options: Bearish bias

What to expect of EUR/USD?

If Catalan President Carles Puigdemont declares independence-

The EUR/USD could drop to 1.1550 (as suggested by EUR/USD options open interest) and further to 1.15 (head and shoulders breakdown target).

As of now, there is consensus among experts that Catalan independence would not trigger an outright breakup of the Eurzone. However, markets could be wrong in assuming so. Moreover, it all depends on how Madrid reacts to independence declaration. As said earlier, "force would not work".

A hardline response would only lead to further escalation of the crisis and a sell-off in the EUR/USD pair.

Spain has negative yields on bonds maturing in three years. The yield curve may flatten (short duration bond yields may spike on economic concerns) if Catalonia declares independence, which will be on the basis of October 1st referendum vote. According to the Catalan government, 90% of participants voted for independence in the referendum, 7.8% voted against and almost 2% of ballot papers were left blank.

Also note that German Chancellor Angela Merkel is on a weak footing. She will have a hard time battling the crisis that threatens the EU project as her coalition partners do not subscribe to her pro-EU stance. The fact that the head of the strongest country in the Eurozone is standing on a weak ground could aggravate the sell-off in the EUR/USD.

• Read - EUR/USD - No signs of stress ahead of D-Day in Catalan Crisis

EUR/USD weekly chart

• 1.1679 - 23.6% Fib R of the rally from 1.0341 to 1.2092 is offering support to the poor
• Bearish 5-MA and 10-MA crossover
• 200-MA is still sloping downwards
• The RSI, which was most overbought since 2007, has turned lower
• Another 100-pip drop may yield bearish crossover on the DMI
• Potential bullish 50-MA and 100-MA crossover (often works as a contrarian indicator)

• The spot looks set to take out support at 1.17 and extend the decline to 1.15 levels. Corrective rallies are likely to capped around the weekly 5-MA level of 1.1850.
• 1.15 is the big level (multiple weekly highs around 1.15 seen in 2015 and 2016 + head and shoulders breakdown target) that could be put to test if the Catalan government declares independence.
• On the higher side, 1.1850 and 1.20 are key resistance levels.