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It looked as if foreign exchange operators were going to take heart from the weekend reports that seemed to play up the possibility of unlimited ECB action in terms of both time and scope, to target interest rate spreads in the euro area. The euro looked poised to extend its recent gains and drag the other European currencies with it. The risk-on environment was going to lift the dollar-bloc currencies. The yen was to stay out of favor. The dollar did make new highs for the move against the yen, but this was not sustained and the greenback has been confined to last Friday's ranges against the other major currencies, including the euro.

As the North American session began, the ECB denied that it has discussed what Italy's Monti has called a "spread shield". This hit the euro, although Spanish bonds remain broadly higher on the session, extending their recent advance. The Bundesbank's monthly report reiterated the reluctance of the German central bank to support ECB bond purchases. Asmussen, the German representative on the ECB governing council tried, over the weekend, to bridge the gap and argued that neither the BBK nor its president Jens Weidmann are isolated, but the BBK's monthly report plays up strident, even if understandable, stance.

That said, Asmussen comments come closest to our understanding of the issues. He acknowledged that the risk premium in the periphery is partly a function of the sense that the euro is reversible and that this leads to an incomplete transmissions of monetary policy. He blamed this on "careless" talk. However, he then went to say that while he prefers Greece remains in EMU, it is up to Greece to ensure this happens. This keeps up the redenomination risk in Greece, and by extension, throughout the periphery. If Greece can be ejected or squeezed out, why not Portugal? Spain? Italy? Cyprus? Where does it stop?

Eurogroup head and Luxembourg Prime Minister Jean Claude Juncker went a bit further than Asmussen. He reportedly told an Austrian paper that he does not expect Greece to leave EMU and only if it refused budget consolidation and structural reforms would it be forced out. Juncker seemed to show more flexibility than the spokesman for the German Finance Ministry, who said that the Greece agreement is fixed in both amounts and time. Yet, we know that there is some scope for flexibility. After all, Spain was given another year to reach its targets.

The German paper Der Spiegel first reported that the ECB was contemplating targeting interest rate spreads. It did not provide a source for this information, but it did not stop the story from being widely circulated. Very little detail was presented, but clearly captured the market's imagination as a dimension of the "modalities" that Draghi had referred to at the last ECB meeting. Any such targets cannot be formally announced because it would quickly become a means of the market challenging the ECB's resolve.

There have been some estimates that if Spanish debt with a duration of 3-years and less was targeted, and the ECB committed to buying the same proportionate amount as the Federal Reserve did under QEII (about 15%), it would entail "only" the purchase of about 30 billion euros. (Why this is picked as a template, when its impact on seemed modest at best is not clear.) Figures that include Italy would, of course, be much greater (closer to 80 billion euros), but the political economic climate in Italy is quite different, and despite Monti's disparaging remarks about the role of parliament, it is not something the technocrat leader would likely decide. Ahead of next Spring's election, the bar for Italy to request aid seems significantly higher than Spain's.

The euro has not closed below its 20-day moving average since August 2. It comes in today near $1.2294, just below the session low. A convincing close below there could see a move to the lower end of the recent range, which can be found in the $1.2150-$1.2200 area.

Source: Euro Churn Burn Continues