Euro Rises against Greenback as ECB Starts Buying Italian and Spanish Bonds

The euro rose against the U.S. dollar on Monday as the European Central Bank decided to start buying Spanish and Italian bonds. Presently, the euro is trading around $1.4345 against the greenback, or 0.46% above its previous close. At the same time, the euro is suffering against the Japanese yen, falling 0.39% to stand around ¥111.67. Lately, the ECB has restricted itself to buying Portuguese and Irish bonds. However, with markets increasingly edgy following the downgrade of the U.S. sovereign debt, the ECB decided to start buying bonds of the third and fourth largest Eurozone members in order to prevent contagion. The ECB is worried that investors might start to flee riskier assets following a historic downgrade of the U.S. sovereign debt by S&P. Over the weekend, S&P downgraded the U.S. credit rating by one notch from AAA to AA+. At the same time, the rating agency decided to reiterate its negative outlook, which means more cuts might follow. For decades, the U.S. Treasury bonds have been the backbone of the world's financial system as the safest investment. With the U.S. credit rating slashed, that might change, which can cause panic among investors, forcing them to sell their riskier assets and seek refuge in precious metals or the Swiss franc. The problems for the Eurozone will start if traders start selling Spanish and Italian bonds, which could push these debt-ridden countries over the edge. Some analysts are skeptical about the ability of the ECB to prevent the financial meltdown in the Eurozone on its own. For instance, the Centre for Economics and Business Research, a London-based think tank, argues that the only way for the Eurozone debt crisis to be over is through the creation of a fiscal union. The think tank argues that the fiscal union will provide legitimacy for the Germans to pay Spanish and Italian debt. However, it remains to be seen if the German electorate can stomach such an idea. Italy and Spain are bound to be the decisive battles in the war for survival of the Eurozone. Both countries easily dwarf the economies of Portugal, Ireland and Greece combined. Therefore, if the Mediterranean giants are forced to ask for a bailout, it is not clear if the rest of the Eurozone, above all Germany, will be able and willing to master sufficient funds. The pressure on the two countries is growing as both Italy and Spain are plagued not just by high debt but also by low growth prospects. In the June quarter, both economies continued to expand at sluggish rates. The Italian economy grew 0.3% in months between April and June, up from 0.1% in the first quarter. Spain reported similar results, growing 0.2% in the second quarter, down from 0.3% recorded in the March quarter. While the Eurozone and the U.S. debt crises escalate, the Swiss franc continues its climb. The Swissy has suffered some setbacks last week as the Swiss National Bank decided to surprise the markets and reduce its interest rates to near zero levels. However, in spite of the central bank's best efforts, the Swissy soon started to rebound. At around 8:42 am GMT, the U.S. dollar is trading around 0.7603 against the franc, or 0.94% below its previous close. At the same time, the Swissy is dangerously approaching parity with the euro as the European currency lost 0.42% of its value to stand around 1.0910. The Swissy is a traditional safe haven for investors in times of crisis and uncertainty. In light of recent developments, it seems as if the tailwinds that have been pushing the franc to record heights are here to stay for a while longer. ACTION ITEMS:

Bullish:
Traders who believe that the recent ECB intervention will restore confidence in Italian and Spanish bonds might want to consider the following trades:

• EUR/USD Exchange Rate ETN ERO is a long play on the euro. ERO may rise if the euro appreciates.

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

• CurrencyShares Swiss Franc Trust ETF FXF. FXF is likely to fall if the Eurozone manages to resolve its debt problems.

Bearish:
Traders who believe that it is just a matter of time before either Italy or Spain, or both, are forced to ask for the financial assistance from the EU, which could be the end of the Eurozone as we 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.

• ETFS Short Swiss Franc Long US Dollar ETC (Sterling) ETF (SCHP). SCHP may rise if the Eurozone debt problems continue.

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