We have watched the EUR/USD move off its highs over the past week on peripheral European concerns. We were waiting for the European/US Basis Swap to widen to reflect the moves seen in the European Basket of CDS before taking the view that the EUR/USD should move lower. Over the past two days the bare-bones Ireland bailout and the renewed spotlight on Spain have both resulted in a severe widening of the basis, with our European CDS Basket and the Basis Swap now suggesting that the EUR/USD should be trading at levels last seen in June of this year.
The Basis Swap suggests the EUR/USD should be trading around 1.2200, While our European CDS Basket suggests a EUR/USD below 1.2000. This adjustment has come very quickly, with a muted relative move in the EUR/USD. In the past we have discussed Asian Central Bank bids as softening market moves, however we note that over the past week Asian Central Banks have been selling USD against their own currencies rather than against the EUR or other SDR currencies as they lower the volatility that has arisen on the back of North Korean posturing. With little to cushion the move, and the technicals pointing lower (especially considering the break of the 200 day moving average) the EUR/USD looks like it is about to start a new considerable move lower. This is good news for Germany and its exports, but will demand a price from Portugal, Spain and Italy. In addition this will put off CNY appreciation until the EUR/USD stabilizes.
Disclosure: No Positions