Revisiting Euro 8217 s 1 35 FX Yields Spreads amp Dax

The latest headlines from Madrid imply that a formal request for aid is inevitable. Whether it takes the form of “applying” for credit line under the €500bn European Stability Mechanism (but not necessarily tapping it), or a full-fledged activation of the ESM, Spain is intending to stabilize market sentiment-without triggering the Outright Market Transactions. It’s also been said Madrid is concerned that full ESM activation may erode resources for Italy in case a request is later made by Rome.

EUR/USD continues to prove that as long as the ECB is anticipated to trigger its OMT (contingent on Spain’s inevitable formal request for help), it shall remain supported above its 200-day moving average of 1.2820s. Yet, as long as Spain remains silent, traders are unwilling to lift EUR/USD above 1.3100s.

EUR Volatility–as measured by the one-month EUR/USD call (Euro equivalent of the VIX) drifts near its lowest level since 2008. Traders’ unwillingness to buy EUR volatility ahead of a looming policy freight train from the ECB is not dissimilar from traders’ gauging of VIX ahead of the Fed’s open-ended QE.

Periphery yields are down 30% since their July highs. 10-year Spain bonds have fallen below their 200-DMA during the last three weeks, which is the longest period these yields have been below this key MA since March, one month after the LTRO 2.

Italian 10-year yields are also down 30% since their July highs, and testing key support levels holding since Oct 2010. Greek bond yields are down 40% since the POST-default/rescheduling in February.

FX and equities continue to show the most aggressive reactions to policy decisions relative to peripheral bond spreads. We stick with the $1.35 EUR/USD call by end of November made three weeks ago. A break above the 1.3180 will be required to extend fresh momentum to the next barrier at 1.3440s — the 100-WMA. 106 remains intermediate objective on EUR/JPY since the call was made on Sep 19, with the rationale of BoJ rhetorical aggressiveness towards its currency and improved sentiment in the broader EUR pairs.