Euro Hit By Growing Threat For Contagion, Fears Of Spanish Bailout

By David Song, Currency Analyst

Talking Points

  • Euro: Spain-German 10-Year Spread Hits Record- High, Cyprus Bailout Looms
  • British Pound: Debt Crisis Drags On UK, PM Cameron To Meet With Top Officials
  • U.S. Dollar: Struggles During Holiday Trade, RSI Falls Back From Overbought Territory

Euro: Spain-German 10-Year Spread Hits Record- High, Cyprus Bailout Looms

The Euro gave back the overnight advance to 1.2623 as the 10-Year spread between Spain and Germany widened to a record-high of 509bp, and heightening finance costs across the European periphery may continue to drag on the exchange rate as it raises the risk for contagion. In response to the ongoing turmoil in the financial system, Spanish Prime Minster Mariano Rajoy assured that there would not be ‘any rescue’ of the region’s banks, but argued that the EU bailout fund should be able to directly recapitalize commercial banks as Bankia, the region’s fourth largest lender, looks for EUR 19B in fresh capital.

As the anti-austerity movement sparks an increased rift within the EU, we are likely to see the governments operating under the single-currency become increasingly reliant on monetary support, and the Governing Council may have little choice but to carry its easing cycle into the second-half of the year as the fundamental outlook for the region turns increasingly bleak. Indeed, ECB board member Panicos Demetriades warned of an imminent bailout for Cyprus should its recapitalization efforts fail to bear fruit, and we may see the central bank employ a range of tools later this year in order to stem the risk for a prolonged recession. As the EURUSD struggles to push back above the 23.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.2630-50, the pair may continue to consolidate over the next 24-hours of trading, but we will keep a close eye on the relative strength index as it bounces back from a low of 30. As the RSI comes off of oversold territory, we will need to see a move back above 30 to see a short-term correction take shape, and we will look to sell rallies in the EURUSD as European policy makers struggle to restore investor confidence.

British Pound: Debt Crisis Drags On UK, PM Cameron To Meet With Top Officials

The British Pound climbed to a high of 1.5716 on Monday as Prime Minister David Cameron is scheduled to meet with Bank of England Governor Mervyn King and Chancellor of the Exchequer George Osborne to further shield the U.K. from the debt crisis, and we may see the central bank continue to strike a dovish tone for monetary policy as the ongoing turmoil in the euro-area dampens the outlook for the U.K. BoE Chief Economist Spencer Dale said the central bank’s forecast casts a ‘pessimistic’ outlook for the region as the debt crisis ‘continues to act as a drag’ for Britain, and the central bank may preserve dovish tone for monetary policy amid the growth threat of a Greek exit. As the U.K. draws up a contingency plan for a euro-area breakup, the public policies in Britain may continue to increase the appeal of the sterling, and currency traders may treat the British Pound as a safe-haven as the government sticks to its budget-cutting measures. As the RSI on the GBPUSD bounces back from oversold territory, the pound-dollar may have found a floor going into the end of May, and the rebound in the oscillator certainly foreshadows a short-term correction in the exchange rate as the pair continues to hold above the 1.2600 figure.

U.S. Dollar: Struggles During Holiday Trade, RSI Falls Back From Overbought Territory

The greenback struggled to hold its ground on Monday , with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR ) tagging a low of 10,147, and we may see the reserve currency consolidate throughout the holiday trade as RSI falls back from overbought territory. As market participants look toward the highly anticipated U.S. Non-Farm Payrolls report on tap for Friday, we may see the dollar hold steady going into June, but the headline-driven market may continue to prop up the greenback as it benefits from safe-haven flows. Nevertheless, as employment in the world’s largest economy is expected to grow another 150K in May, the gradual recovery in the labor market may sap speculation for additional monetary stimulus, and the Federal Reserve may continue to soften its dovish tone for monetary policy as the outlook for growth and inflation picks up.

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

To be added to David's e-mail distribution list, send an e-mail with subject line "Distribution List" to dsong@dailyfx.com.

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Original Article: http://www.dailyfx.com/forex/fundamental/daily_briefing/session_briefing/us_open/2012/05/28/Euro_Hit_By_Growing_Threat_For_Contagion_Fears_Of_Spanish_Bailout.html