Peripheral Nations Are Making the Euro Pay Its Dues

Contagion fears in the Euro-zone continue to undermine the 17-nation currency. Italy and Spain are currently on the forefront of decimation by the market’s action as yields continue to rise through the roof. Italian 10-year bonds rose to the highest level since inception of the Euro-zone as rates hit 5.54 percent. Spain did not fare well either, as yields on 10-year bond increased to 5.92 percent.

Whenever yields of peripheral nations increase compared with those of the German Bunds, the market generally sells off the EUR/USD currency pair as investors seek safe havens. We believe that the EcoFin meeting will continue to bring more uncertainty to the market and yields of peripheral nations will continue to widen compared with safer German Bonds. The situation can be noticed in Greece, as yields on 2-year notes rose to 31.62 percent, a Euro-zone record. The yields between 10-year German Bunds and similar Greek bonds widened to 1,437 basis points.

Spain and Italy possess as much as €6.3 Trillion, in a combination, in public and government debts. In turn, the European community will not be able to grant a meaningful bailout if either of the nations will be seeking one. It is undoubtedly important to note that the size of the Spanish economy exceeds a combination of Portuguese, Irish and Greek economies. Any nuances of a potential downfall of either the Italian or Spanish economies could cause an even bigger impact on the Euro-zone. The situation in Greece, however severe it seems, is just the calm cool breeze before the summer thunderstorm. The Euro will be in for extremely harsh times if Italy or Spain, even hint at greater problems.

Nonetheless, the market participants are already betting against Italy. With a roaming EU bank stress test expected to show 15 out of 91 banks failing, government officials need to act before contagion pulls the rest of the Euro-zone into unclimbable well. If more than 15 EU banks fail the stress test, participants can take the Euro down to 1.38 against the United States Dollar in a short term. However, a passage of greater than anticipated numbers will cause a temporary relief on EU economic system. During the EcoFin meeting, members must converge on the solution to the Greek debacle. A lack of a definitive solution could further push the Euro-zone in a worse situation. Currently, markets are beginning to reflect the rationale that a partial default will need to be taken place. However, an involvement of the private sector needs to be thought out before the plan is initiated. Credit agencies, however, will not bide on the default in an optimistic fashion. Nonetheless, a solution needs to be presented in order to curb contagion fears roaming in the market place.We currently, hold that more downgrades of Portuguese credit standing will follow from remaining agencies. It is probable that Portugal, in turn, would require a second bailout. Currently, Greece is expected to receive additional funds in terms of a second bailout. Portugal, it seems will need additional funds in order to remain solvent. Italian Debt to GDP ratio is currently at 119 percent, or $2.6 Trillion of a $2.1 Trillion economy. An expansion of EFSF program is highly certain at this point. However, the EU needs to convince the German government to extend the EFSF program.

Despite the fact that the situation in the Euro-zone continued to magnify in its intensity, IMM positioning reflected an expansion of net Long EUR positions. CFTC Commitment of Traders showed that net long position in Euro extended to $7.8 Billion. Nonetheless, a squeeze of long positions could further accelerate downward pressure in the EUR/USD currency pair.