Euro Continues to Slide as Debt Woes Continue on Eurozone Periphery

The euro continued to slide against major currencies on Tuesday as early optimism about the new Greek bailout evaporates and pressure starts mounting once again on Spain and Italy. At the moment, the euro surrendered 0.26% of its value against the U.S. dollar to stand around $1.4213. At the same time, the European currency fell below the ¥110 mark against the Japanese currency. The euro currently trades around ¥109.91, or 0.13% below its previous close. Tuesday is expected to be a quiet day without major data about the health of the Eurozone economy. Therefore, all eyes are focused on the debt problems in the Eurozone periphery. It seems that the second Greek bailout plan failed to shake off fears over long-term sustainability of public finances in the Eurozone periphery. In the immediate aftermath of the deal, markets reacted positively to the news as the euro strengthened and bond yields fell for Italy and Spain. All that optimism seems to be gone now as the Eurozone periphery continues to struggle to contain its debt. The rating agencies, led by Moody's are on a warpath against the debt-ridden countries. Since the second Greek bailout, Moody's has first downgraded its rating on Greece, followed shortly by S&P, and then on Cyprus as well, citing fears that the island nation is too exposed to the Greek debt. This is exactly what the Europeans were trying to prevent: contagion. Moody's is the first to open up a new front in Cyprus. It remains to be seen if S&P and Fitch will follow suit. Moody's does not have any plan to stop at Cyprus, it seems, as the rating agency issued a warning to Spain. Moody's is worried about the health of the Spanish economy and is reviewing the country's current rating of Aa2. If Spain's rating is downgraded, it will most likely be by one notch to Aa3. As the Spanish economy continues to be subdued and debt problems continue to mount, the Spanish government has had enough and has called on early elections. The ruling Socialist party has suffered a devastating defeat in the country's local and regional elections earlier this year. It is also expected that the opposition will prevail in the general elections, now scheduled for November. The current Prime Minister Zapatero has already stated he will not seek a third mandate. Some analysts might be worried that reforms will be put on hold while Spain prepares for a change in government. One of the reasons why the ruling Socialists have had enough is probably the pressure from the EU to implement more radical austerity cuts. It seems as if they have left a lot of dirty work for the next administration. Markets are already punishing Spain as the country's bond yields continue to grow. The Spanish 10-year bond yield rose today by 16 basis points to 6.36%. At the same time, the yield spread over the German bonds with similar maturity has risen to 393 basis points, a new Euro-era record. The pressure is mounting on Italy as well. On Tuesday, the Italian 10-year bond yield jumped 18 basis points to 6.18%. Spain and Italy are now forced to pay higher interests to convince traders to buy their bonds. However, some large investors are still reluctant to buy their debt. Among them is Merrill Lynch Global Wealth Management, which has around $1.5 trillion in assets. The second Greek bailout, which has a participation of the private sector, has signaled that it is possible that private bondholders might have to take a “haircut” on their investment. These fears are now spreading to Spain and Italy. Italy and Spain are the largest Eurozone economies, after Germany and France. Preventing these countries from suffering the same fate as Ireland, Portugal and Greece will determine if the Eurozone can survive in its current form. The Italian and Spanish economies might be too big to fail, but are equally too big to bail out. Spain's economy, the smaller of the two, is twice the size of Greece, Ireland and Portugal combined. Bailouts are already very unpopular in the Eurozone center, i.e. in countries like Germany, Finland and the Netherlands. It is very doubtful that German Chancellor Angela Merkel will be able to persuade the German people to come to the rescue of the faltering Mediterranean giants. ACTION ITEMS:

Bullish:
Traders who believe that the Eurozone has shown an impressive determination in fighting the debt crisis, and will ultimately find a solution to its debt woes, might want to consider the following trades:

• WisdomTree Dreyfus Euro Fund EU is a long play on the euro. EU may rise if the euro appreciates.

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

Bearish:
Traders who believe that Germany will lose its patience with the Eurozone periphery, and will allow some countries 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 may rise if the euro depreciates.

• Market Vectors Double Short Euro ETN DRR is another short play on the euro. However, DRR should rise more than SEUP if the euro depreciates.

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