The euro fell sharply on further turmoil for Greece and broader euro zone stability, failing to move higher on hawkish commentary from European Central Bank president Jean Claude Trichet and standing at risk of further declines. Trichet used his trademark “Strong Vigilance” phrase to virtually guarantee that the bank would raise rates at its July meeting. The effect was initially euro-bullish, but the rally was short-lived as concerns mount over Greek government solvency and contagion to broader periphery nations.

A relatively limited week of European economic event risk leaves the EURUSD to trade off of moves in broader financial markets, but it will be critical to listen to any and all commentary on a second fiscal aid package for Greece. ECB President Trichet made headlines when he unequivocally denied the possibility of an ECB-sanctioned Greek debt restructuring. He went as far to say that the central bank would no longer accept Greek debt as collateral for loans on a debt restructuring—a shot across the bow to those that believe it will be a solution for the Greek sovereign debt crisis.

Germany’s Finance Minister Wolfgang Schäuble defied the ECB chief when he said that a restructuring of privately-held Greek debt would be a requirement for a bailout, and officials are set for a showdown on the clear disagreement. It seems a foregone conclusion that the embattled Greek treasury will need assistance but clear uncertainty on the “how” and “who” has only further destabilized market sentiment. Indeed, the cost to insure against Greek sovereign credit default (Credit Default Swaps) surged to a fresh record high amidst the uncertainty.

All told, Greece represents a relatively small percentage of the total euro zone and even a debt default would cause arguably little direct damage to the EMU. Yet its effect on broader confidence in the viability of the currency union would substantial and the risk remains that of contagion. Can Greece’s troubles reignite fears over Ireland, Portugal, and worse still—Spain and Italy? The spread between Spanish 10-year debt yields and the equivalent German benchmark trades near its widest since the inception of the euro. At approximately 9 percent of euro zone GDP, it would be significantly more difficult to aid the Spanish economy should it fall under similar stress. This will be an important point of contention going forward, and one gets the sense that Greek issues could have a domino effect on the broader EMU.

Debt concerns have had a negative effect on broader financial market risk appetite, and indeed the US Dow Jones Industrial Average has posted its worst 6-week performance since 2002. Given sharp week-to-week swings in market sentiment, it is difficult to take a lasting bias on the Euro/US Dollar. Yet a continuation of recent market concerns and DJIA declines would benefit the safe-haven US Dollar and hurt the euro. It will be critical to monitor risk sentiment in the week ahead and how it affects key forex pairs.

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