EUR/USD was markedly weaker  falling through the 1.3300 level on the first trading day of the week as a steep drop in  the Shanghai index and disappointment over Germany’s reluctance to add more capital to the EFSF fund prompted heavy selling in the pair unwinding a significant part of last week’s gains. Ahead  of the EcoFin meeting scheduled for today and tomorrow, German Finance Minister Wolfgang Schäuble said that Berlin does not support increasing the size of the euro zone rescue fund, noting that last week’s  reports that the EU is planning such a move were a “misunderstanding”.

Mr. Schauble’s remarks surprised the market which was expecting the EcoFin ministers meeting to take up the issue this week and were in sharp contrast to those of ECB   President Jean Claude Trichet who stated last week that he prefers the EU to expand the EFSF facility both “quantitatively and qualitatively”. The reluctance of German fiscal policymakers to discuss the expansion of the EFSF is clearly the result of stiff domestic opposition to provide further bailout funds for the region’s troubled peripheral economies and could pose serious political and economic problem  if it creates an impasse within EU.

 

As we noted earlier,” Although EU has already allocated 440 Billion euros to EFSF, markets continue to be concerned that even that gargantuan sum may not be enough if Spain runs into financing trouble. The growing policy differences between Europe’s key core economies on this issue (with France arguing for a more aggressive stance)  may weigh on the EUR/USD as the week progresses if the stalemate is no resolved.  Last week the pair saw a vicious short covering rally in the wake of relatively stable auctions of EZ periphery debt and expectations of further strengthening of the EFSF. However this week as optimism on further capital injections starts to fade, the forces of risk aversion could unwind much of EUR/USD recent gains.”

 

With US on MLK holiday and all capital markets closed, the price action during the North American session should remain muted. With no event risk on the calendar the currency markets are likely to maintain their  focus on Europe and the latest pronouncements from the EcoFin meeting. At present it appears that the EU ministers will not take up the issue of shoring up the EFSF fund until March, which may be too late for the markets. This week EZ credit markets see a flood of short term issuance from Northern European economies as well as Spain and Greece. Spain will also issue 10 and 13y bonds on Thursday. If those auctions prove disappointing and EUR/USD  slides below the 1.300 level, the pressure on EZ officials to  react more quickly to market concerns will increase significantly and policymakers may to scramble once again to appease the markets. 

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