Euro looks set to remain under pressure

Last week was a bad one for the euro, but an excellent one if you were short on the euro dollar, which finally broke below the 200 day moving average and ended the week just short of the 1.2900 price level. So what can we expect for the euro this week, and is the euro likely to be punished one again?

The key driver behind the euro is of course the ongoing issues with sovereign debt, and in particular how this plays out in the related bond markets, and this week the spotlight is likely to be focused on Portugal as the latest casualty on a list which seems to get ever larger. If we start with Germany, the power house of Europe at the moment, and the unfortunate cornerstone for European stability, the spreads between German bonds and other EU member states are now reaching record levels, with Portuguese 10 year bonds in particular now at a critical point, having risen 70 points in last week’s trading session alone. According to the Lisbon government, the threshold of pain is around the 7% level, and it is at this point that the government suggested it would look towards the ECB for assistance and a subsequent bailout package along the lines as agreed for Ireland last year. With yields now touching 7.1% we appear to have reached the trigger point at which the Portuguese have run out of options, and request help from the the triumvirate of the ECB, the EU and the IMF, and we may even seen this take place early next week, triggering alarm in the forex markets as a result.

Portugal is not the only patient on the sick list – the latest to join is Belgium, which although generally not considered to be one of the leading economies, nevertheless, it was always considered one of the ‘safe’ but boring countries, which simply carries on doing business in a traditional and relatively quiet way. The irony of course for Europe is that Herman von Rompuy is now the European Council President, and no doubt increasingly embarrassed at his countries woes. If we go back to August last year, the 10 year bond yield fell to 2.8%, yet as of last week it had risen over 4%, along with other peripheral EU member states, so the question now is, will Belgium be forced to follow suit and request a bailout package, along with Ireland and possibly Portugal?

In simple terms there are three principle reasons why investors have targeted the bonds of the lesser EU states, and the first is the supply that is about to hit the market, with Portugal due up first on January 12th, as it offers its 2014 and 2020 bonds for sale, with Italy and Spain holding their own auctions later in the week. In an auction held last week in Portugal, investors charged substantial premiums to hold short term bonds, suggesting that the take up in bonds this week may be low. Secondly, the world’s largest buyer of bonds has issued a statement to the effect that it will not be participating, adding further concerns to an already worrying picture. Finally if Portugal and other member states have to increase yields in order to attract investors, then this simply increases investor concerns over a likely bailout – it is almost a self fulfilling prophecy. Higher rates, means potentially lower growth, which in turn could mean investors selling their bonds, with yields rising further as investors seek safer havens elsewhere, a cycle, that if perpetuated could lead to a collapse and default in the longer term. Belgium’s problems are of course compounded by it’s lack of any full time government at present, and as such investors are unlikely to be forgiving, and until this political situation is resolved, risk appetite may wain, causing yet further problems in Europe.

If all this were not enough for the beleaguered euro, one further issue remains, and this is the Commission’s plans to overhaul the regulatory framework for Europe’s banking sector, and one of the proposals on the table at present is to give regulators the power to write down the debts of any bank that they considered to be in trouble, with a worst case scenario of converting this debt to equity.

So, where does all this leave the euro? Weak certainly, but to rush into further short positions misses the other side of the equation which is Asia, whose central banks continue to buy the currency in favour of the US dollar, and indeed this was a feature of trading just prior to, and immediately after the Christmas period, as we waited for the markets to return to normal. The price action followed the same pattern for several days with a fall in the London and US session, immediately reversed with buying in Asia, helping to lift the currency higher, with only a full return to work last week having the necessary pressure to break this cycle. This may indeed be a continuing feature, but with the above problems now building once again, and the threat of contagion an ever present problem, the longer term outlook for the euro looks bearish, and in my view we can expect to see a move towards the 1.2550 – 1.2650 region in the short to medium term, where I will be closing out some of my current positions from their levels at 1.3100 and beyond.

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About Anna 1036 Articles
Hi – my name is Anna Coulling and I am a full time currency, commodities and equities trader. I have been involved in both trading and investing for over fifteen years and have traded many different financial instruments, from options and futures to stocks and commodities. I write and publish articles ( mostly for free ) for UK and international publications on a wide variety of financial issues, and in particular I enjoy helping others learn how to invest and trade.

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