Despite Trichet taking out his "bazooka" - the ECB agreeing to buy Italian and Spanish bonds - the relief period in the EUR/USD and other EUR crosses has been short lived.

The announcement by the ECB certainly worked to lower the yields on both Italian and Spanish bonds, and helped to boost the share prices of Spanish and Italian banks, but it was concerns over the global economy and position shifting in the wake of the US downgrade that caused other sectors in Europe -  miners, technology firms, and car makers - to fall.

Yields in Italy and Spain Ease Post-ECB Announcement:

Here's a look at Italian 10-Year yields today, which we see eased from an open near 5.69% to 5.35%, a 12% decline in terms of yield:

And Spain's 10-year yields fell by a similar amount, sliding from an open near 5.66% to a low of 5.21% so far in NY trading:

This shows us that at least from the sovereign debt front, the ECB announcement has had the positive impact expected. We have to see if this drop in yields is sustainable.

.. But EUR Still Falls

That positive aside, there was a myriad of pressures facing the single currency:

From ForexLive: Report ECB had sent a secret letter to the Italian government instructing them what measures they wanted to see and the fall out from that; very poor euro zone sentix data, comments from Jim Rogers re further euro zone downgrades; comments from German government spokesman that there isn't going to be an increase in the size of the EFSF and news Italian banks sharply increased borrowing from ECB in July all weighed on the single currency.

  • As we can see from the above hourly chart, the EUR/USD has retraced 61.8% of its swing from Friday and we test the 1.4180 level as support.
  • A break here would target the 1.4120 and our lows from last week near 1.4050.
  • On the flip side, if we hold the current 61.8% retracement and find support here, then

Markets are trading in a risk-off environment and a sharp sell-off in equities helps to boost the USD as a safe haven, and even with the latest step by the ECB to stem contagion, market participants are not convinced.

.. Main Sticking Point is Germany's Reluctance on Expanding EFSF

One main sticking point being the size of the EFSF and that to truly be able bring stability it needs to be raised - from its level near €440 billion to maybe €1 trillion - something Germany is against, and would put fiscal pressure on France and other guarantors if all the EFSF was drawn down.

The fate of the EUR therefore is going to play out with the evolving positions held by Germany in regards to the EFSF and its role in stemming this crisis, and so far Germany does not want to shift its position beyond what was agreed to in the July 21st summit.

From Wall Street JournalGermany Opposes Larger Rescue Fund -

"Barely 12 hours after a reluctant European Central Bank breathed new life into the euro project, German politics dashed hopes that Europe would soon receive a bigger bulwark against a spreading government-debt crisis.

A spokesman for German Chancellor Angela Merkel, Christoph Steegmans, removed hopes of a more robust European Financial Stability Facility, saying the fund will stay as agreed at a July 21 European Union summit. "The EFSF will remain what it is, and keep the volume it had before July 21," Mr. Steegmans said at a regular government press conference.

The European Commission has asked for a massive increase in the EFSF's current lending capacity of €440 billion ($628.23 billion) guaranteed by euro-zone governments. Market watchers said a new volume of up to €1.5 trillion or more might be needed to reassure investors that the fund can offset government solvency threats."

Germany has a way of throwing a huge kink into plans to stabilize the sovereign debt situation, but it usually comes from its reluctance to put more of its taxpayers' money on the line to help other Euro-zone countries. We'll see how the effect of the ECB buying program squares with the expectations the market has for what needs to be done with the EFSF.

Those two opposing factors have so far come out on the side of EUR weakness, though we still remain within our ranges from last week in the EUR/USD. Once the risk aversion from the S&P downgrade gets worked through the financial system, if the ECB keeps Italian and Spanish yields down, it will be an opportunity to buy the EUR at lower levels.

Nick Nasad
Chief Market Analyst
FXTimes