For the past several weeks we’ve been warning that the pomp and circumstance surrounding the European Central Bank’s bond-buying program was overdone, for one main reason: conditionality. As originally noted, we still believe that the program inherently would force Spain into taking a bailout via a convoluted circular feedback mechanism: the ECB promises to save Spain and yields fall; Spain doesn’t act quick enough because of the low yields, and investors get anxious pushing yields higher; Spain promises to consider a bailout, pushing yields down again; investors get anxious with no conditions outlined, sending yields higher…etc.

The gist is that the only way yields would stay perpetually lower would be if Spain took a bailout. Without the sovereign bailout, then yields would skyrocket as the ECB’s ‘bazooka’ could not be fired. So we’re at this point now – European equity markets have cratered today as the Spanish 10-year note yield has inched back above 6.00% at some points today. Sentiment is becoming very bearish very quickly again on Europe – so looking the other way may be warranted.

From a technical perspective, the Australian Dollar and the Euro have taken the brunt of the beating the past few days, but critical support now lies below. Both the AUDUSD and EURUSD have traded into their 200-DMAs today, and with short-term technical indicators showing divergence on both the 1-hour and 4-hour charts, it is possible for a bounce given the correct fundamental catalyst. We suspect that any formal announcement of Spanish aid could do the trick – this is expected to occur around October 4, just ahead of the commencement of the European Stability Mechanism (ESM) on October 8.

Taking a look at credit, peripheral European bond yields are moving closer towards panic levels again. The Italian 2-year note yield has increased to 2.361% (+11.6-bps) while the Spanish 2-year note yield has increased to 3.230% (+18.8-bps). Similarly, the Italian 10-year note yield has increased to 5.148% (+7.0-bps) while the Spanish 10-year note yield has increased to 5.910% (+22.3-bps); higher yields imply lower prices.

RELATIVE PERFORMANCE (versus USD): 11:55 GMT

JPY: +0.10%

NZD:-0.15%

CAD:-0.15%

GBP:-0.15%

CHF:-0.30%

AUD:-0.30%

EUR: -0.36%

Dow Jones FXCM Dollar Index (Ticker: USDOLLAR): +0.13% (+0.32% past 5-days)

ECONOMIC CALENDAR

Aussie_and_Euro_Breakdown_to_Key_Levels_Against_US_Dollar_body_Picture_3.png, Aussie and Euro Breakdown to Key Levels Against US Dollar

The economic docket is barren today, with the exception of some light US data due out shortly after the cash equity open. At 10:00 EDT / 14:00 GMT, the USD New Home Sales (AUG) report is due, and only a slight uptick is forecasted. Considering last week’s better than expected housing data and a continued increase in prices over the past several months, a beat could be in the cards.

TECHNICAL OUTLOOK

Aussie_and_Euro_Breakdown_to_Key_Levels_Against_US_Dollar_body_Picture_1.png, Aussie and Euro Breakdown to Key Levels Against US Dollar

EURUSD: With the pair closing below the 61.8% Fibo retracement (February 2012 high to the July 2012 low) at 1.2934 yesterday, a move towards the next level of support in the mid-1.2800s was to be expected. This coincided with an Evening Star candle cluster on the 4-hour chart at the 20-/50-SMA confluence, a bearish sign. Interim support comes in at 1.2825/40 (20-EMA, 200-DMA, late-April swing high). Near-term resistance lies at 1.2915 (5-EMA), 1.2930/35, 1.3000, 1.3145, and 1.3165/75 (September high).

Aussie_and_Euro_Breakdown_to_Key_Levels_Against_US_Dollar_body_Picture_2.png, Aussie and Euro Breakdown to Key Levels Against US Dollar

BB represents Bollinger Bands ®

USDJPY: No change from yesterday as the pair moves towards near-term support at 77.65/70: “The USDJPY continues to move lower off of the pullback at trendline resistance last week, spurred on by a general feeling of disappointment on the BoJ’s newest stimulus measures has created the ideal sell-off situation. Now that price is below 77.90, 77.65/70 (June 1 low), 77.45/50, and 77.10/15 (September low) are in focus. A close above 77.90 leaves open the possibility for a rebound to 78.10/20, 78.60 and 79.10/30 (100-DMA, 200-DMA, descending trendline off of the April 20 and June 25 highs).”

Aussie_and_Euro_Breakdown_to_Key_Levels_Against_US_Dollar_body_Picture_4.png, Aussie and Euro Breakdown to Key Levels Against US Dollar

GBPUSD: The British Pound has held up remarkably well amid a flight to safety. However, the GBPUSD has now traded close to the key 1.6120/40 level, our guide for bullish/bearish price action. As long as the GBPUSD closes above said level this week, the door is open for a move towards 1.6400 by the end of the month. The former April swing highs at 1.6260 (by close), 1.6300 (by high) are in focus, now that the descending trendline off of the April 2011 and August 2011 highs broke last week. Below 1.6120/40 support comes in at 1.6030/35 (20-DMA), 1.5970 (ascending trendline off of August 2 and August 31 lows, former channel resistance off of June 20 and August 23 highs), and 1.5770/85 (late-August swing lows).

Aussie_and_Euro_Breakdown_to_Key_Levels_Against_US_Dollar_body_Picture_5.png, Aussie and Euro Breakdown to Key Levels Against US Dollar

AUDUSD: The descending trendline off of the August 9 and August 23 highs has kept the pair supported the past few days has broken, and whatever base the 20-EMA at 1.0420/25 was providing was only short-term in nature. Near-term resistance comes in at 1.0375/80 (descending trendline off of the August 9 and August 23 highs, 50-EMA),1.0425 (20-EMA, mid-August swing lows), and 1.0480/85. Interim support comes in at 1.0335/40 (200-DMA), and 1.0270/80.

--- Written by Christopher Vecchio, Currency Analyst

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

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