Euro Recovers as U.S. Debt Deal Fails to Impress Investors

The euro recovered against the U.S. dollar on Wednesday as the U.S. debt deal failed to reassure investors that the U.S. debt crisis will be resolved quickly. Presently, the euro added 0.96% to its value against the greenback to stand around $1.4341. At the same time, the European currency is trading once more above the ¥110 level against the Japanese yen. At the moment, the euro stands around ¥110.59, or 0.9% above its previous close. President Obama signed the new debt bill into law after the motion has been voted in by the U.S. Congress. The deal did prevent the worst case scenario, i.e. the default of the world's largest economy. However, the deal failed to impress analysts and investors as the U.S. stock markets ended in the red on Tuesday. The immediate response of Moody's and Fitch was to leave their triple-A rating unchanged. However, Moody's has placed negative outlook on the U.S. debt, which means there is a possibility of a rating downgrade in the next 12 to 18 months. On the other hand, Fitch stated it will review the U.S. position more thoroughly before deciding on its next moves, but has not ruled out following Moody's lead and placing negative outlook on the U.S. rating. Traders are now waiting for the response of S&P, which has been far more critical of the U.S. than its rivals. Rating agencies have been under fire from the European leaders after the agencies downgraded their rating on the Eurozone members on a number of occasions. The three rating agencies, which form an oligopoly, are all U.S.-based and some traders might be worried if the agencies show lenience towards the United States. Rating agencies are under a lot of fire because they failed to spot the financial meltdown. It may be very difficult for them to regain credibility if their actions concerning the U.S. debt are guided by patriotism instead of reality. On the other side of the Atlantic, Italy and Spain look more likely to suffer the same faith as Ireland, Greece and Portugal. The situation in Spain has deteriorated in recent days, prompting its Prime Minister Zapatero to postpone his vacation. Recently, premiums to hold Italian and Spanish bonds over German ones is reaching new heights, which makes it more difficult for Spain and Italy to finance their debt on open markets. The same course of events has already forced three Eurozone members to ask for the financial help from other members. Spain currently has to offer higher interest to sell its debt than Italy, but Italy has much higher overall debt levels, which is surpassed only by Greece among the Eurozone nations. On Wednesday, Italy started crisis talks with EU after yields on Italy's debt continued to rise. To make matters worse, the participation of the private sector in the second Greek bailout is starting to take its toll on banks' performance. For instance, Societe Generale, a French giant, has seen its June quarter profits slump by 31% to €747 million. The French bank's weak results were mainly due to a €395 writedown on its Greek debt holding. Traders will watch anxiously for the June quarter results of other banks, above all French and German ones, which have the biggest exposure to the Greek debt. The Eurozone economy did post some encouraging results today, however. According to Eurostat, retail sales in the euro area increased 0.9% in June compared to the previous month. In May, retail sales plunged 1.1%. On an annual basis, retail sales in June were still 0.4% below their level in June 2010. At the same time, the Eurozone Services PMI for July has been revised upwards from 51.4 to 51.6. The Eurozone will need its economic recovery to pick up very soon, after it becomes painfully obvious that the second Greek bailout has failed to reassure investors that the Eurozone finances are on their way back to sustainable levels. Therefore, investors will keep their eyes on the health of the economies of Germany and France, the Eurozone's main locomotives. ACTION ITEMS:

Bullish:
Traders who believe that the Eurozone economy will pick up soon, increasing tax revenues and helping the debt-ridden countries get their finances back in order, might want to consider the following trades:

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

• ProShares Ultra Euro ETF ULE is another long play on the euro. However, ULE should rise more than FXE if the euro appreciates.

Bearish:
Traders who believe that it is just a matter of time before Italy and Spain suffer the same fate as Greece, Portugal and Ireland, which might be the end of the Eurozone as we currently know it, may consider an alternate positions:

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

• ProShares UltraShort Euro ETF EUO is another short play on the euro. However, EUO should rise more than SEUP if the euro depreciates.

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