Talking Points

• US Dollar, Yen Fall Overnight Amid Profit-Taking on Risk Aversion Bets
• Euro FinMin Summit in Focus as Traders Look for Policymakers to Step Up
• Italian Bond Yields Rise Ahead of Bond Auction, Pointing to Funding Stress

TheUS Dollar andJapanese Yen slumped in overnight trade as Asian stock exchanges rose ahead of a summit ofEurozone Finance Ministers set to begin today in Brussels. The MSCI Asia Pacific regional benchmark index rose nearly 2 percent. TheAustralian and New Zealand Dollars outperformed, adding as much as 0.9 and 0.6 percent against their US namesake.

The summit is expected to focus on disbursement of the next tranche of Greek aid, but with bond yields soaring and sovereign stress heating up across the Eurozone over recent weeks, the possibility that larger issues make it onto the docket seems high. Although it’s probably a stretch to say that traders are optimistic after a long series of would-be “comprehensive” solutions failed to stem the crisis, the probability of an unexpectedly positive outcome has apparently proven substantial enough to drive profit-taking.

Looking at theEuro as a natural proxy for assets sensitive to Eurozone debt crisis developments, the recovery noted since the start of the week seems hardly surprising after speculative net short futures positions in the single currency reached a 17-month high last week (according to data released by the CFTC). Given the extent of recent selling, this means investors betting on continued turmoil have significant profits to protect at this point, and the off-chance that Eurozone policymakers will finally get their act together and take real strides toward putting their house in order puts those gains in danger.

As we discussed in ourweekly Euro forecast, risk-supportive developments can come in two forms. One option is closer fiscal integration that allows for some sort of shared responsibility for regional debt (like the so-called “Eurobonds” idea making the rounds recently), allowing high-debt countries to import some of the positive reputation of prudent ones. The other is the emergence of theEuropean Central Bank as a true lender of last resort to countries shut out of market funding by prohibitively high borrowing costs. Such an arrangement would see the ECB wield their balance sheet to introduce large-scale bond purchases, a scheme likely resting on QE-type financing.

Importantly, the ability of uncertainty-driven profit-taking to boost asset prices is inherently limited. The markets appear unsure rather than encouraged, so the reversal in sentiment is likely to last only as long as it takes traders to pare back bets on continued risk aversion to bring portfolios closer to a neutral rather than an overtly positive setting. In fact,S&P 500 stock index futures are conspicuously trading lower in late Asian trade, hinting the rally may already be running out of steam. Sizing up the calendar, the outcome of anItalian bond auction is likely to be in focus. The spread between Italian and benchmark German 10-year yields has widened by 17bps from yesterday, pointing to continued funding stress.

Asia Session: What Happened

Euro Session: What to Expect

Critical Levels

CompleteTable of Support and Resistance Levels –www.dailyfx.com/technical_analysis/pivot_points/

---Written byIlya Spivak, Currency Strategist forDailyfx.com

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