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Foreign Exchange

Euro could plunge to $1.30 after Italian meltdown

The euro finally succumbed to selling pressure on Wednesday as the Italian bond market went into meltdown, with technical analysts predicting more downside for the single currency.

Some predicted the euro could trade down to as low as $1.30 against the dollar, as the Italian bond market headed into the same self-reinforcing downward spiral as those in Ireland, Greece and Portugal ahead of their bailouts. The single currency plunged over three cents against the dollar to $1.3560 by late afternoon in London, after proving remarkably resilient to the worsening developments in Rome during the past few trading days.

The initial trigger for the move was the decision by LCH.Clearnet, Europe’s largest clearing house, to raise its margin requirement for trading Italian debt, forcing funds to liquidate their bond positions.

Reports that the European Central Bank had been aggressively buying Italian debt failed to ease the pressure on Rome, with the yield on its benchmark 10-year bonds rising to a euro-era high of 7.43%.

Signs of stress were visible elsewhere in the market, with three-month EURUSD basis swaps rising to their highest levels since September, as European banks scrambled to acquire dollars through the swap market.

The breach of the $1.3600 level, the bottom of the recent range in EURUSD, was extremely significant, analysts said.

“We have had the sell-off in risk and the euro we expected as the market has moved from want-to-sell to need-to-sell mode, and has taken out support at $1.36,” says Maurice Pomery, chief executive at Strategic Alpha.

Technical analysts at Citi re-entered a short position in EURUSD as the downside move in the currency pair gained momentum.

“We have re-established our short EURUSD position at $1.3652 with a stop loss at $1.3875 and retain our view that we can see a move towards and possibly below $1.30 in the weeks ahead,” analysts say.

“We believe this move has begun and will likely accelerate below $1.3580.”

Kathleen Brooks, research director at Forex.com, said the break through $1.36 opened the way for EURUSD to test the low of $1.3200 witnessed at the start of October.

However, she said that this time the market was extremely short euro, according to the latest data on speculative positioning from the CFTC.

“Short euro positions have recovered slightly since the start of October, but remain back at mid-2010 lows,” adds Brooks. “This suggests that further declines might not be as sharp as we have seen, since so many people are short the single currency already. But it is no surprise that the euro and other risky assets have come under pressure as Italy has gone to the wall.”

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