Italy Rocks Euro

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Today's Idea Tuesday, July 12, 2011

The Euro faces a new set of challenges with Italy's debt problems rising to the surface. The nation has the second highest debt to GDP ratio in the EU behind Greece, and Italy's GDP is over six times that of Greece. A debt compromise in the US could pave the way for further advances by the US Dollar versus the Euro. The close below the 1.40 mark yesterday could signal a technical breakout, but further technical confirmation is needed. Some traders may wish to consider looking for further downside in the Euro by entering into a bear put spread, for example, buying the August 138 puts and selling the August 1.36 puts for a debit of 0.0050, or $625. The trade risks the initial cost and has a maximum profit if $1,875 if the underlying September futures contract closes below 1.36 at expiration.

Fundamentals

The Euro was rocked by new concerns of contagion, after the EU held an emergency meeting to discuss distressed Italian debt. Italy was not in the same spotlight that Greece, Ireland, Portugal and Spain found themselves in recently. In fact, when discussing the Greek bailout, some EU policymakers had actually used Italy as an example of a nation that was making necessary concessions and reforms to other distressed nations. This is why the news of the emergency meeting had rocked the Euro to the extent that it did. The EU realizes that it must quash Italian concerns quickly to prevent yields from exploding, which would slow economic growth and make further bailouts of European states more expensive and difficult. Dragging their heels could result in further declines in the Euro. On the other side of the Atlantic, the US faces its own debt problems in the form of the debt ceiling debate. It appeared that significant progress had been made over the weekend, but both parties ultimately could not come to a compromise. If the US is able to come to an agreement over the debt ceiling, the greenback could extend its gains over the Euro. Failure to compromise would force traders to make extremely tough decisions, which could wreak havoc on the currency markets and cause extreme volatility.

Technical Notes

Turning to the chart, we see the September Euro contract closed below support at 1.4000, although not in very convincing fashion. Many traders will likely be looking for a more significant close below support before accepting a downside breakout has taken place. Friday, the Euro closed below the 100-day moving average, and yesterday's close marked a significant close below the average, which can likely be seen as a negative. The RSI indicator is nearing oversold levels, which may offer some buying support for the market. However, some traders may wish to note that some downside breakouts can be more explosive when the indicator is oversold.

Rob Kurzatkowski, Senior Commodity Analyst


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