Now that the single currency has hit a 1-year low and is closing in on the psychologically important 1.30 level, you may be wondering how much further can it fall. Unfortunately I believe that the 1.30 level is more of a psychologically important level than a technical one. The currency pair should break it easily and fall to its “real” support level of 1.2960 (see chart below). Until the Germans officially vote in favor of the bailout package for Greece, the euro will have a tough time rallying.



If the EU/IMF announcement this weekend was aimed at supporting the euro, it has failed miserably. The euro has continued to weaken because of the abundance of unanswered questions. Here are just a few of those questions:

- Will Parliamentary Approval be Achieved?
- What will be the final package size?
- How quickly will aid come?
- How painful will the austerity package be for Greece?
- How much social strife will it cause?
- Will market turn on Spain, Portugal, Ireland and Italy?
- Will the ECB Completely Change the Rulebook because of Greece?

The concern ranges from how long it will take before Greece will receive funds to the possibility of contagion. Even though Eurozone finance ministers have approved a EUR110 billion bailout package, there still needs to be Parliamentary approval from individual nations that will affect the speed and size of the final bailout. Eventually Germany will come through because underneath all of the political backtracking, the government knows that in order to avoid a more damaging and embarrassing bailout of German banks, they need to bailout Greece first. There will be strikes and protests, but at the end of the day, the aid is needed to stabilize the region’s economy, support investor sentiment and prevent the euro from falling further. There is even talk that the Germans could be fast tracking their vote. However even if Greece is successfully bailed out, investors could quickly turn on countries like Spain, Portugal, Italy and Ireland especially if there are additional downgrades by rating agencies. This morning, there are rumors floating around that Spain could ask for an E280 billion bailout. As a result of these developments, the European Central Bank has amended their collateral rules for the second time because of Greece.

With fiscal stability still not achieved, there is a good chance that ECB President Trichet will remain dovish when he delivers his post ECB meeting press conference on Thursday, which is part of the reason why the euro has sold off today.

Finally everyone is watching Greek bond spreads. Here is a chart that I created on Bloomberg which shows the relationship between the EUR/USD and the 10 year yield premium that investors demand for holding Greek bonds over German bunds. As you can see, the yield has hit approximately 600bp and poised to blow out even further. Given its close relationship with the euro, I expect that to minimally mean a break of the 1.30 level.

 

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.