Euro Edges Higher as S&P Puts the U.S. Rating on Review

The euro edged a bit higher against the U.S. dollar and the Japanese yen on Friday, as S&P puts the U.S. credit rating on review for a possible downgrade. At the moment, the euro added 0.18% to its value against the greenback to trade around $1.4168. At the same time, the euro rose 0.21% against the Japanese yen to ¥112.16. It seems S&P has joined the U.S. debt party, following the announcement by Moody's it is placing the U.S. credit rating on review for a possible downgrade. S&P in essence repeats Moody's concerns over a stalemate between the White House and the Congress over raising the debt ceiling. If the agreement is not reached by August 2, the U.S. government will have to brace itself for a shutdown. S&P said there is a 50% chance that the U.S. credit rating will be slashed from the current triple AAA level within the next three months. The two parties cannot agree on how to cut the massive U.S. budget deficit. The White House proposal contains tax increases for the rich, which the Republicans swiftly rejected. The White House, on the other hand, will not accepts the opposition's proposal, as it views it as being too harsh on the ordinary Americans. The Financial Times reports another option of dealing with the stalemate. This option involves sending the motion to raise the debt ceiling to the Congress, where it will fail, only for President Obama to veto the Congress decision. This scenario would be a victory for the Democrats, as the Republicans would need to muster a two-thirds majority in the House of Representatives to overturn President Obama's veto. A possible U.S. default on parts of its debt would most likely send shockwaves through financial markets. The inability of the two political parties to reach an agreement might have historical consequences for the U.S. as the leading superpower. At the moment, the U.S. government debt is considered as the safest investment. A possible rollover or even default on some debt would result in the U.S. loosing this prestigious title, with the chances of quickly regaining the title looking very grim at the moment. The title “safest investment” carries not only prestige but low interest rates. As a result, the looming government shutdown will make servicing the U.S. debt more difficult, since the U.S. will need to pay higher interest rates to investors in order to persuade them to buy the U.S. government bonds. Concerns over debt seemed to trump recent remarks by the Fed Chairman Ben Bernanke. On the second day of his testimony before the Congress, Bernanke back tracked on his earlier comments about a possible extension of the quantitative easing program. Bernanke now claims the U.S. central bank is not prepared to implement QE3. A program of quantitative easing was in essence a type of expansionary monetary policy which had put a lot of headwind for the dollar. Europe has its shares of problem as well. Traders are anxiously waiting for the results of the bank stress test. The tests are performed in order to ensure that the banks have enough funds to withstand a possible downturn in the world economy. Some analysts are worried that these tests are not strict enough, even with recent modifications, after only seven out of 91 banks failed the test last year. To add oil to the fire, a German bank Helaba withdrew from the test in order to avoid failure. The bank stressed that the European Banking Authority, which runs the test, stated it will accept silent participation as a capital reserve, only to change its mind. Such random withdrawal from the test will certainly raise some eyebrows among investors, asking themselves what is the point of the test if banks are allowed to drop out of it on their own willing. The situation in Italy has calmed down a bit, very good news indeed for the euro, as the Italian Senate passed through a reform package aimed at eliminating Italy's budget deficit over the course of three years. Italy has the send highest public debt to GDP ratio in the Eurozone, right after Greece, and investors became increasingly agitated by Italy's possible inability to repay its debt. On Thursday, the Italian government managed to sell a package of bonds on open markets, but only at a very high cost. Italy's bond yields reached new heights, as the Italian government was forced to pay an interest of 5.9% on 15-year bonds and 4.9% on 5-year bonds. The Europeans will hope that recent decisive action by the Italian authorities will prevent further increases in the costs of servicing Italy's massive debt. The Eurozone is under immense pressure as Greece is desperately trying to keep its head above the water, and the situation in Portugal and Ireland is looking increasingly like the Greek scenario number two and three. At the same time, the patience of the ordinary people all over Eurozone is wearing thin. On the one side, bailout countries are seeing massive protests against new austerity measures. On the other side, new bailouts are becoming equally unpopular in the Eurozone center. As a result, many governments in the Eurozone center should brace themselves for popularity losses if more bailouts are needed. In this environment, the Europeans cannot allow themselves to have another front opened in the Eurozone's third largest economy. Any bailout for Italy will dwarf all bailouts in Greece, Ireland and Portugal combined. If Italy falls, it is very likely that the Eurozone will be forced to raise the white flag. ACTION ITEMS:

Bullish:
Traders who believe that the Eurozone will be more successful in resolving its debt problems than the U.S., which should provide some headwind for the euro, might want to consider the following trades:

• CurrencyShares Euro Trust ETF FXE is a long play on the euro. FXE will rise if the euro appreciates.

• ProShares Ultra Euro ETF ULE is another long play on the euro. ULE will rise more than FXE, however, should the euro appreciate.

Bearish:
Traders who believe that there are just too many debt-ridden countries in the Eurozone for Germany and the rest of the Eurozone center to handle, which makes it very likely that some countries are going to have to leave the Eurozone, may consider an alternate positions:

• ETFS Short Euro Long US Dollar ETC (Sterling) ETF (SEUP) is a short play on the euro. SEUP will rise if the euro depreciates.

• Market Vectors Double Short Euro ETN DRR is another short play on the euro. DRR will rise more than SEUP, however, should the euro depreciate.

Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.