EURUSD finds itself under relentless selling pressure this week (touching a low of 1.4033) as Greek bond yields continue to rise and the cost of insuring against sovereign default in Greece creeps further upwards. The yield on Greek Sovereign 2yr bond has surged to 4.96% having been around 1.70% at the end of September, and the cost of CDS (insurance premium to protect against default) has risen to 344 basis points. In layman's terms, that means for every EUR 1m of Greek government bonds, an investor would have to pay EUR 344k to insure their investment. And unlike the Dubai debt crisis, this problem will not have any quick or simple solutions. Indeed, it seems that the worries over sovereign default are starting to spread within the Eurozone. With other economies like Ireland, Portugal, Spain and Italy also seeing increasing distrust from CDS markets and the contagion even beginning to affect UK and French CDS, we may be beginning to see the emergence of a new driver of FX markets for 2010. Currencies are often noted to follow the performance of other asset classes, and often currency markets will tend to track certain markets more than others. In 2008, commodities were the predominant focus as oil soared higher above $147 per barrel, and EURUSD powered to new highs above 1.6000 - indeed the correlation of the two assets was over 0.9. In 2009, equities and credit markets took the reins as the driver of USD trends. For 2010, it seems plausible that the single most important driver of currency trends will be sovereign credit spreads. The extraordinary measures that were undertaken by governments around the globe to prop up the economy during the financial crisis have certainly stabilized equity markets, but at the cost of monstrous budget deficits. Government debt will be under scrutiny this year, raising the possibility of sovereign default to significant levels, and investors will likely shift their attention from analyzing so-called 'risky assets' as they did in 2009, to analyzing 'risk-free assets' i.e. government bonds in 2010.

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