Italian bond yields soar, euro resilient

With markets focused lar­gely on Italy at the start of the week, after re-assuring news from Greece, the euro surprisingly held firm, and risky assets did not sell-off aggressively as one would imagine. Most major currencies spent most of the earlier part of the week trapped in a tight range.

After opening the week higher, the euro traded nervously later on Monday and Tuesday. The single currency was supported initially by news over the weekend that Greek politicians had come to an agreement to form a national unity government, which would negotiate the passage of recent austerity measures and secure its next tranche of aid payment, and more importantly avoid a controversial referendum which threatened to destabilize the region.

But as European markets opened on Monday, focus shifted to Italy, which was facing political instability driving Italian bond spreads over German bunds to a euro-lifetime high and putting pressure on the single European currency. Italian bonds came under heavy pressure, and rose to 14-year highs at one point on Monday, amid growing concerns over Italy’s debt sustainability and commitment to reforms.

Risk appetite improved again later on Monday, after rumours emerged of Silvio Berlusconi’s imminent resignation and new French budget measures were announced calming markets. EUR/USD rallied one big figure as the news of Mr Berlusconi stepping down hit the wires, rising from 1.3682 to 1.3813. However the risk rally was short-lived as Berlusconi soon quashed these rumours and risk sentiment dampened.

Trading remained choppy on Tuesday, ahead of a crucial vote on Italy’s public finances, and a probable vote of confidence on Mr Berlusconi’s leadership. Italy was now predominantly at the centre stage in Europe’s debt saga, with markets seemingly having digested the trauma from the Greek referendum and central bank meetings from Europe and the United States.

Thursday of last week, the European Central Bank in the first governing council meeting chaired by new President Mario Draghi cut its interest rates by 25 basis points to 1.25 per cent. In his press conference, Mr Draghi said Europe is heading toward a mild recession, and growth should be moderate in the second half of 2011, downside risks have been materialising and keep endangering growth.

The euro was surprisingly resilient to the events over the past week. It managed to hold steady and avoid a massive sell-off despite growing uncertainty from the euro zone debt crisis and a rate downgrade by the ECB. Forex investors seem to be cautious over taking aggressive short euro positions after getting burnt in October, when the single currency spiked to a two-month high at 1.4247 versus the buck.

The Swiss franc was the exception earlier in the week, as it plummeted across the board on Monday and extended its decline early on Tuesday. However, it trimmed some of its losses later on Tuesday, but remained down against its rivals on the week. The swissie surged on Monday, after comments over the weekend by Swiss National Bank Chairman Philipp Hilderbrand and Vice Chairman Thomas Jordan on Monday. The Swiss central bankers both said the SNB was continuously monitoring the situation and will act when needed. Mr Jordan piled on the heat by saying the swissie is still over-valued and is among the most over-valued in the world.

Safe-haven flows, with uncertainty over who will succeed George Papandreou as Greek Prime Minister and higher borrowing costs for Italy, were expected to lift the swissie, but those comments from Swiss policymakers increased expectations for a rise in the policy floor on EUR/CHF which is now set at 1.2000. In fact, the head of a Swiss business group said it would welcome a “Christmas present” from the SNB raising the floor to 1.3000.

EUR/CHF surged to above 1.2456 on Tuesday, while USD/CHF peaked at 0.9068, a three-week high. However, Mr Jordan cooled expectations for an imminent intervention on Tuesday, when he said it would be wrong to engage in competitive devaluation, sparking a sell-off in EUR/CHF and USD/CHF. The swissie rebounded and was up on Tuesday, but remained 1.50 and 1.30 percent lower on the week versus the euro and dollar respectively.

Finally if a corrective rally in EUR/USD (as it appears to be weathering the storm) was to gather steam on a series of buy orders above 1.3850, it is expected to run into significant resistance by 1.3930, which represents the 50 per cent Fibonacci retracement of the move from 1.4247 to 1.3608, October high to November low slide, and the 55-week moving average by 1.3937. A move to the downside is seen supported around 1.3750, with forex traders citing a series of stop orders below 1.3720 which could accelerate further weakness.

Upcoming FX key events:
Today: German CPI, French CPI and UK BoE Interest Rate Decision and Asset Purchases Target.
Tomorrow: UK PPI and US Preliminary Michigan Sentiment.

FX technical key points:
EUR/USD is bearish, target 1.2850, key reversal point 1.4100.
EUR/GBP is neutral.
USD/JPY is neutral.
GBP/USD is bearish, target 1.5125, key reversal point 1.6250.
USD/CHF is neutral.
AUD/USD is bearish, target 0.9500, key reversal point 1.0800.
NZD/USD is bearish, target 0.7100, key reversal point 0.8200.

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Mr Xuereb is a trader at RTFX Ltd.