Euro Struggling, Deja Vu All Over Again, Except...

In price action eerily reminiscent of last week's reaction the the EU's offer of a 100 bln euro line for Spanish banks, the euro rallied initially and subsequently gave it all back plus some.  The euro's advance carried it to almost $1.2750 and has now fallen to a low of about $1.2580 in the NY morning.   The other major currencies are taking their cues from the euro. 

Peripheral yields are soaring, except Greece, where the Troika is sounding as flexible now and there has been some talk that Greece could be given an extra couple of years to meet its deficit targets.  Would it have been so flexible if Syriza won?   Spain's 10-year is up almost 30 bp and 2-year is up nearly 50 bp.  Over the past 60 days, the direction of the euro and Spanish 10-year yields are 90% correlated.  The correlation with the 2-year is almost 95%. 

Spanish stocks are under pressure as well.  The IBEX is off 2.25%  late in the session, with financials off over 3%.  Remember the banks bought more Spanish bonds that the government issued as they also absorbed the sales from other, international investors.  Thus the LTRO reinforced the linkages between the banks and the sovereign.  Many of the banks have weak balance sheets and now as the sovereign bonds sell-off, the balance sheets are taking another hit. 

Italian bonds are also selling off.  The 10-year yield is up 15 bp to 6.05%.  The 2-year yield is up 18 bp.  Italian and Spanish bonds are moving in lock step. Italian and Spanish bonds have moved in the same direction almost 93% of the time over the past 60-days.  At the level of percent change, the correlation is near 84%. 

As was the case last week, there is talk that the Eurosystem of central banks may have checked on prices.  The SMP program has not been restarted, but the many suspect, we are nearing that point.  The G20 meeting is no the forum that can arrest the rot.  Nor will the meeting of Eurogroup finance ministers of the numerous bilateral meetings planned later this week.  These are all jockeying for position ahead of the EU Summit at the end of the month. 

A major difference between this week and last week is the proximity of the FOMC meeting.  Expectations of some action continue to run high.  We have often argued against ideas that QE is negative for a currency.  We understand the theory, but in practice it has not been the case.  The yen's strength despite QE stands out.  The fact that US dollar rallied within days of QEI and QEII being announced provide other examples.  Even with sterling's roughly half cent decline today, it remains well above levels seen last week prior to the UK Treasury and Bank of England unorthodox measures and signal that additional gilt purchases (QE) would resume as early as next month.