FYI | Oct 16 2014
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
A major shift has happened in the last couple of days, Greece, who everyone thought was on the mend, saw its bond yield cross an important line. If you cast your mind back 3 years you may remember that in the heat of the sovereign debt crisis, when Europe’s struggling periphery saw their bond yields cross above 7%, it was considered the point of no return. Well, late on Tuesday, Greek 10-year yields did just that, they crossed this important line, and have continued to push higher on Wednesday.
I did not expect to be watching Europe’s peripheral yield spreads with Germany. However, this old chestnut is back and the chart below shows Greek (white), Spain (orange) and Portugal (yellow) 10-year bond yields with Germany. As you can see in figure 1, Greek yield spreads have risen sharply, Portuguese yields have turned higher, and the Spanish spread has also started to widen. At this stage, the contagion effects are minimal, as Spanish and Portuguese yield spreads with Germany are still at relatively low levels. However, as you can see in figure 2, Greek, Spanish and Portuguese yield spreads have tended to move in the same direction for most of the last 5 years, although Greek yields have tended to overshoot more. This does not bode well for the other “at risk” countries in the Eurozone.
So why are peripheral risks rising right now?
- Growth fears: Europe’s growth forecast was revised down by the IMF for this year and next year, disinflation has taken a firm hold and even Germany is showing signs of stress. This is not good when you have a giant pile of debt. In fairness, Europe could do with a little inflation to eat away at its debt pile, which is why it is imperative that the ECB takes more action to get rid of the threat of deflation.
- Germany: As we mention above, even Germany is struggling. The ZEW survey for October suggests that there is a good chance that the US will fall into technical recession this year. If Germany’s economy starts to suffer, who is going to pay for all the bailouts? This essentially leaves Europe without a true lender of last resort, which could make some of Europe’s most troubled nations less credit-worthy.
- Political risks: Some of Europe’s member states have fragile governments right now. The French government nearly collapsed earlier this year, Italy’s Five Star Movement is gaining popularity once again and trying to get Italy to leave the currency bloc; in Greece the radical leftist anti-EUR party SYRIZA hold a strong lead in the opinion polls. The Greek political issues could continue to grow if the current government do not win a majority at next year’s Presidential election then SYRIZA could call a snap election putting them in a good position to run the country.
Rising bond yields are merely a reflection of the troubles that have resurfaced in the currency bloc. We tend to think that the economy is the biggest threat, and if growth does not pick up sometime soon then we could see rising bond yields spread beyond Greece into Portugal, Spain and even Italy.
Right now, there is no sovereign crisis, but the fact that Greek yields have crossed the 7% threshold is a warning sign that all is not well. Investors are ditching the highest risk peripheral debt and ploughing their money into German yields, 10-year German yields have fallen to another record low on Wednesday, which suggests that stress levels could be starting to rise.
What now for the EUR?
EURUSD is shrugging off the Greek news, for now, however if yields continue to rise and we see 8 or 9% in 10-year Greek bond yields, or if we see contagion start to spread and other peripheral yield spreads start to rise, then it could trigger some selling pressure in the single currency. We continue to think that the risks to the EURUSD are to the downside, and the market could fade any rallies towards 1.2680 and then 1.2710. In the short term, the first level of support is 1.2625 then 1.2600; however the main target is still 1.2500, the low from 3rd October.
Figure 1:
Figure 2:
Now you can follow us on Twitter: http://twitter.com/FOREXcom
Re-published with permission. Views expressed are not by association FNArena's (see our disclaimer).
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 warrant 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, the author does not guarantee its accuracy or completeness, nor does the 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.
Futures, Options on Futures, 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 and commodity futures, 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 Conduct Authority (FCA) in the UK, the Australian Securities and Investment Commission (ASIC) in Australia, and the Financial Services Agency (FSA) in Japan. Please read Characteristics and Risks of Standardized Options (http://www.optionsclearing.com/about/publications/character-risks.jsp).
Technical limitations
If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
