Euro eases back, eyes next week onslaught of event risks.

A fairly heavy flow of Euro-negative developments today, though the Euro only suffered an orderly consolidation. Next week’s event risks will tell us where the pair really stands – and could lay the groundwork for the rest of the year.

Early in the day today, word was circulating that the Chinese might be interested in participating in the EFSF SPV to the tune of USD 100 billion, though the Klaus Regling, the EFSF’s head, later downplayed the potential for a quick deal with China. The Euro rally’s foundations were challenged from a couple of other directions today, as well, though the currency remained fairly resilient. First, a pair of German SPD lawmakers complained recently to the German Constitutional Court that it should be illegal for the small parliamentary committee to make key decisions regarding the distribution of EFSF funds, and the court today upheld their case and “banned” the finance committee’s activities, questioning its constitutionality. Requiring that the entire Bundestag has to vote for every EFSF move would slow the process.

In other news, the Irish government downgraded its GDP expectations by “at least 1%) for 2011 from the 2.5% forecast from April of this year and Fitch said that it would consider the 50% Greek haircut to be a default, and thus a trigger event for CDS on Greek sovereign debt. The ISDA has not yet announced whether this will constitute a trigger event. If it doesn’t rule in favor of an event, one has to wonder whether this could more or less scotch the market for CDS on sovereign debt instruments, with unknown consequences for volatility, as it removes the market’s ability to hedge its exposure to the underlying debt.

Finally, an Italian debt auction went off rather poorly today, resulting in yields backing up, as Nick Beecroft points out, to level’s they traded at (close to 6% for 10-year paper) just before the summit results were known.

In other EU developments, French President Sarkozy promised more budget austerity to salvage France’s AAA rating and Kenneth Rogoff (of “This Time is Different” fame) suggested that Greece will eventually leave the EU despite the latest bailout deal.

The three scenarios revisited
Earlier this week, we outlined three potential scenarios, the lower odds maximum confidence/risk upside blowout scenario (10% probability) and the evenly weighted alternatives – one in which the market continues to see a squeeze for a time in EURUSD and other risk assets (We suggested to max 1.42 in EURUSD and perhaps 1300 in the S&P500) and the other in which the market immediately sold off after the EU summit on sell-the-fact reaction to what was a more or less known outcome. Only the latter scenario has been eliminated for the moment, but the move after the summit has been so forceful that it almost demands we see a significant consolidation in the coming few days if the first scenario is not to have its odds raised considerably (i.e., that markets will continue to vault higher in another classic liquidity induced melt-up that did wonders in early 2009 and then in late 2010.

Chart: EURUSD
EURUSD vaulted all the way past the 200-day moving average, but let’s see if it can hold that break through next week’s key string of major event risks before judging the technical significance of that move. The pair saw two false breaks of the 200-day moving average in November of last year and January of this year that were reversed the next day in the former case and four days later in the latter. Also, Fibonacci levels are interesting here, as the high yesterday was at the significant 0.618 Fibo for the sequence from the May top just shy of 1.4950 to the Oct. 4 low below 1.3150.



Looking ahead
We’ve made a very sharp move here in markets and crossed a few lines in the sand in currencies, if a bit fewer in other markets. As we await an answer on which scenario will prove the correct one (as described in the paragraph above) we suspect the answer will be forthcoming next week or possibly the week after, given the string of key event risks on the immediate horizon. The most important of these include the FOMC meeting (any hints on NGDP targeting or even QE3?), ECB meeting (rate cut?), G20 meeting (further commitment from SWF’s?) and the US employment report. So the next two week may well set the tone for the rest of the year.