Euro Forecast to Fall Further as Spanish Yields Surge Post Bailout

The Euro continues to fall sharply despite news of a Spanish bailout, and indeed forex correlations suggest it could continue to fall against the safe-haven US Dollar (ticker: USDOLLAR) on surging Spanish government bond yields.

The Euro initially rallied following an announcement that Spain secured a bailout worth up to €100 billion through the weekend, but sell-offs in sovereign debt emphasize that investors remain very skeptical of the Spanish bailout. Indeed, interest rates on Spanish 10-Year Government Bonds recently hit their highest levels since the inception of the Euro.

Forex correlations show that a continued sell-off in Spanish bonds and rise in yields would likely push the Euro lower. Bearish European fundamentals and our own technical euro forecast likewise point to continued EURUSD weakness.

Forex Correlations Summary

View forex correlations to the SPDR Gold ETF Trust (GLD), United States Oil Fund ETF (USO), SPDR Dow Jones Industrial Average ETF Trust (DIA), UK FTSE 100 Index, and IShares Silver Trust ETF (SLV) prices.

Correlation between Euro/US Dollar and Spanish Government Bond Yields

Euro/US Dollar Exchange Rate (lhs)

Inverse of the Spanish 10-Year Government Bond Yields (ETF) (rhs)

The correlation between the Euro/US Dollar exchange rate and Spanish bond yields remains strongly negative, and indeed we believe the Euro could hit fresh lows as bonds surge. To see why Spanish debt could continue recent sell-offs, some historical perspective is in order.

European fiscal crises came to the forefront of traders’ minds starting over three years ago when ratings agencies downgraded Greek sovereign ratings as government debt surged to 113% of GDP. All was supposedly solved when the Euro Zone and IMF announced a joint Greek bailout packages in April, 2010. Since then Greece has received two official bailouts and counting, while the same crises forced similar rescues of Ireland, Portugal, and now Spain.

Investor skepticism on the Spanish bailout seems natural; the announced €100 billion package seems inadequate given claims that Spanish banks could need as much as €270 billion in recapitalizations. The net result is that markets continue to sell Spanish government debt despite the announced bailout, and we believe bonds could trade lower (yields higher) going forward. Correlations suggest the Euro could subsequently fall to fresh lows against the safe-haven US Dollar.

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

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