This week US government debt breached the $10 Trillion barrier for the first time in history of the republic. Non-farm payrolls lost 159K jobs. The Congress passed the biggest boondoggle against the will of 9 out of 10 the voters it represents. And yet the dollar rallied to yearly highs against the euro. For the beleaguered euro bulls it was truly a week of wonderment and mayhem.

Why, despite all the bad news in the US, is the euro so weak? Because, hard as it is to believe the news from the other side of the Atlantic may actually be worse. As analysts have pointed out, “After Ireland, under a threat of bank runs, guaranteed all deposits in its banks, which have liabilities that are 300% of the country’s GDP, more events in Europe follow at the speed of light. Greece also gave a 100% guarantee. These are empty promises; if all banks would fail, governments would be incapable of living up to them. These are made to prevent bank failures. But that leaves the cause for those failures unattended. And there lies the rub. The Netherlands, only days after it bought 49% of Fortis with the Belgians for $16 billion, just fully nationalized the bank’s Dutch branches. Price tag: $24 billion.”

This weekend the Europeans are convening their own “bailout” summit, but the French and the German disagree on what to do and the currency markets fear Rome will burn while Nero fiddles. The lack of a coordinated centralized response, combined with Trichet’s tone deaf stubbornness regarding ECB uber hawkish monetary policy have now created a perfect storm for European credit markets as well. The move in the euro these days reflects not so much a concern over the worsening economic climate in the region, but outright fear over whether the single currency can survive this crisis in tact.

While we think that the doomsdayers are wrong and the euro experiment will weather this storm, we are in no way confident of that view. The economic benefits of a single currency have been immense for the Euroland region, but we are not naive enough to think that politics wont sabotage even the best laid economic plans. In short the EUR/USD trade continues to be a mess and is likely to remain very volatile in the near term until the markets get some transparency on the risks involved. 1.3500 may prove to be a good spike bottom this week, especially if the markets start to focus on the fact that the Fed may cut rates another 50bp in October, but the picking bottoms in the EUR/USD is an exercise fraught with pain. In the meantime short USD/JPY continues to be a much cleaner bet on dollar weakness and as we slide towards 10K on the DJIA 100 USD/JPY is likely to follow.

Boris Schlossberg serves as director of currency research at GFT, and runs bktraderfx.com.