Don't forget that you can now follow Forex.com's research team on Twitter: http://twitter.com/FOREXcom

Spanish bond yields have surged to their highest ever euro-era levels, reinforcing the fact that bailouts have not helped to alleviate credit risk in the currency bloc. Below are a few of my thoughts about today's market action. I have been doing media commitments all morning, so here are some initial thoughts, I will write in more detail later.

  • Although Italy's bond auction this morning went well (i.e., people bought the debt) the yields that Italy had to pay were unsustainable - over 6% for 8-years. With a debt to GDP ratio of 120% these yields are thoroughly unsustainable and it is becoming more and more likely that Italy could be the next domino to fall after Spain.
  • Spanish banks are effectively closed out of the capital markets. They borrowed nearly EU 300bn from the ECB in May, leaving one wondering if the EU 100bn bailout of the banking sector will be enough and if there will be a second, even third round of finance for Spain further down the line.
  • Merkel spoke to her Parliament today - she was non-committal about future action although she said that more needs to be done to save the currency bloc. She reiterated her support for the Fiscal Pact and thus austerity (Greece better watch out). There was no talk of a redemption fund as had been reported in the UK press.
  • The Greek election risk is heating up. The leader of the radical Syrizia Party said that he thinks Europe will buckle and give Greece more funds without the need for austerity. Good luck. I wouldn't fancy his chances playing chicken with Merkel and things could get a lot worse in Greece. Expectations are for a win for pro-bailout New Democracy party (so nothing to worry about then; until they want to negotiate the bailout pact they signed before June's election.)
  • This is the type of situation the EU authorities need to get involved with. Rumours of the ECB checking the price of Spanish debt are rife. Added to this, apparently EU finance ministers are on standby for an emergency call post the Greek elections on Sunday.

Market moves:

 

So why hasn't the euro fallen? Even though the Spanish 10-year yield has backed off from 7% in the past hour it is still at an unsustainable level. The euro barely blinked. It has been stuck between 1.2550-1.2590 so far today, which is a fairly tight range for this pair. When ranges narrow like this it can be a precursor to a coming storm. So watch out for an explosive reaction to the Greek election/ rising Spanish bond yields.

German bond yields have been moving in line with Spanish yields so far today, which suggests that the markets expect Germany to do something like guarantee European debt (hence its credit rating is deteriorating), yet until there is a concrete announcement then no one is willing to pile into Spanish, Italian debt or other risky assets like the euro or stocks (hence the narrow ranges). Thus the markets seem poised to rally if there is an announcement of official action to sort out this crisis. However, the risk of disappointment is large so be careful. If we continue without any announcement form EU officials then we could see the current EURUSD range start to widen, with a bearish bias. 1.2450 is immediate near-term support below 1.2550.

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

d: +44.(0).20.7429.7924 | f: +44.(0).20.7929.2010 | M: +44 (0) 7919.411.957  | e: kbrooks@forex.com| w: www.forex.com/uk

23 College Hill | 3rd Floor | London EC4R 2RT

Now you can follow us on Twitter: http://twitter.com/FOREXcom

Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that FOREX.com is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. FOREX.com is regulated by the Commodity Futures Trading Commission (CFTC) in the US, by the Financial Services Authority (FSA) in the UK, the Australian Securities and Investment Commission (ASIC) in Australia, and the Financial Services Agency (FSA) in Japan.