EUR/USD (1.3600) Friday’s relief rally induced by the formation of Italy’s technocratic government proved short-lived. As the 6.29% yield on Monday’s auction of Italian five year bonds shows, investors perceive that even with a new government, the political playing field might not have changed enough to push through austerity reforms and contain near-term contagion. Peripheral bond yields and spreads are rising again. For example, the Spanish spread widened to a euro-era high yesterday. These developments are pushing observers to the conclusion that the ECB stepping up its sovereign bond purchases is the ultimate and inevitable measure to restore confidence. Even as the ECB continues its internal, but public debate about its role as lender of last resort, the record low bond yields in the UK and US show that buying by strong central banks plays an undeniably crucial role in preventing the markets from entering the vicious cycle of high yields, worsening debt dynamics, and further bond selloffs. Of course, debt monetisation is strictly forbidden for the ECB. However, even if the eurozone governments were to come up with additional bailout funds, respectively, collateral, some authority would have to coordinate eurozone bond buying. In the absence of a functioning EFSF, the ECB can hardly be taken out of the loop.
Again, the euro failed to secure a stabilisation (above 1.3875). We therefore still see it as vulnerable to a decline to as low as 1.3360/80.
Market Bias Index
Cable snapped back to perceived fair-value yesterday after a brief excursion. This is an increasingly familiar pattern. Despite the high volatility, traders are likely to be comfortable with prices near current levels.
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Deutsche Bank
Fixed Income Research – Global