Event Risk Requires a Higher EUR

There is little love for Spain this morning. Even having the reigning European and World cup holders has not prevented the beleaguered nation from escaping a Moody's credit rating downgrade. Late yesterday, they downgraded the country by three notches and is keeping them on review for further downgrades. This puts the Iberian nation and Europe's fourth largest economy just one notch above junk status. Their actions has enabled Spanish bonds to printing currency bloc high yields again. It seems that the market is worried that a full bailout for the country is not that far away.

This is an aggressive move by the rating agency, especially taking into account that the negative rating watch will be reviewed again in the next three months. Expect Spain to fall out amongst Euro's big boys, from a benchmark perspective. This downgrade can only further reduce the market appetite for Spanish product. All of this is a vicious circle. Moody's highlights the country's concerns over its debt burden arising from the proposed financial earmarked bailout and yet downgrading increases the cost of capital and in the current Euro economic climate allows the piranhas to squeeze Spain even closer to submission.

Spain aside, the litmus test this morning focused on Italy and how was she was to cope coming to market. The investors Spanish reaction managed to push Italian yields higher ahead of issuance, while German bunds again benefitted from the resulting flight to safety. The Italians got their allotted +EUR4.5b 2015, 19, 20 BTP's away, despite being at the top end of the range (It has been considered a strong auction). So far, all seems to be fine, despite mounting concerns that the country will be the next Euro casualty. This negative investors momentum, which has pushed the level of spreads and yields so high, is not reflecting the fundamental picture of Italy. Even being in a recession, the country is not broke yet!

All of this is increasing tension amongst the Euro leaders. They are bureaucrats, they are politicians and they need to get elected. With perception being everything, they have to be seen to be doing the right thing by their electorate. Spanish Prime Minister Mariano Rajoy has declared “battle” on the ECB and has also pushed back against Finnish advice on how to use its €100b bank bailout. Even the Austrian Finance Minister was made to retract a forecast that Italy would need aid. With no one focus, how is the EUR to survive? The run of meetings over the next few weeks (G20, Fed and Spanish review) provides plenty of scope to move the crisis response forward, should the outcome of this weekends Greek election cause increased market concern.

The SNB's decision were very much expected, there were no “capital controls, additional tools or measures announced, and no change in policy rate.” Policy makers are trying to downplay their currency's attractiveness and buy more time. Being short CHF is the trade everyone and their mother currently has on. The market is betting that the SNB floor will hold. However, it could be tested depending on the outcome of this weekend's Greek elections. The reality, the market is pro-franc against the EUR.

Now that Italian issues are out of the way, where to now? The EUR's short coverings do not change the bearish setup. All asset classes are expected to move into a tight range over the next couple of days, as traders pare or square up positions before the weekend and before liquidity becomes too much of a premium.The market is concerned that a victory by the far left Syriza party could see the country reject the terms of its latest bailout package (+EUR130b).

Event risk will have many wading to the sidelines, however, braver souls prefer to short this market, even if it currently feels better bid. Investors remain a better seller on rallies, looking to off load some EUR's ahead of the psychological 1.26 handle. Their objective is to retest last weeks lows of around 1.2435. Through this strong support, downward momentum should pick up because of the plethora of stops parked here. Despite daily momentum remaining negative, and the nearer this weekend event risk is, the market will want to tighten up their overall exposure. Record shorts want a lower market, but, playing the percentages and lowering one's exposure because of even risk will require higher prices first!

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EUR's Still to Go