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The debt crisis weakened the euro, but the drops aren’t so significant, and are puzzling many. Well, most of the moves in the bond markets have been within the zone: from the periphery to the core, to the benchmark. As the wolves are closing in, also the German benchmark is in danger of being broken.

And that’s the moment that EUR/USD will plunge. There are already some signs of this kind of movement. Will the ECB step up its efforts?

Extension of bond rout

The sell off of European bonds has extended: it’s not only the peripheral countries such as Greece and Portugal, not only the “too big to bail” countries like Italy and Spain, but it already reached very solid countries like Finland and Austria.

Fear is gripping the markets, and there is a “flight to quality” – a flight to German bonds. German bonds (or bunds) are the benchmark against which all other yields are compared to. Germany is now not only the core of the core, but probably alone in the core. But also German bonds aren’t immnue forever.

Germany’s shoulders

Germany currently carries a lot of European weight on its shoulders. It it carries even more weight, it may collapse as well. But also if it doesn’t pick up more tabs for other European countries, it still depends on them: a significant recession in all the countries around Germany will also weigh on the German economy, despite significant German export to countries outside of Europe.

The euro has weakened in the current round of the debt crisis, but it still remains strong. The crisis triggered a lot of capital movement, but a serious part was within Europe: from the periphery to the core. Massive money didn’t exit the euro-zone. Not yet.

Negative headlines moved money from the periphery to the core (risk aversion), and positive headlines moved it from the core to the periphery (risk appetite).

Breaking the bench (mark)

When the markets will discover and decide that also Germany isn’t really as safe, the benchmark will be broken. There are already initial signs of this, coming from Asian investors.

If nothing is really safe in Europe, money will stop flowing within the zone, but will flow out: US treasuries, British gilts and also Japanese and Swiss bonds will be preferred over Germany’s bunds.

And that’s when a much more significant fall in the value of the euro can be expected. 1.25 is certainly possible, and also 1.17 (the launch price of the euro) isn’t too far in such a case.

ECB Role

The European Central Bank is the only body capable of stabilizing European bond markets, but the Germans still reject this, as they believe that it isn’t the role of the central bank – that governments should be more responsible.

This sounds right in theory, but the markets are burning. ECB efforts have been quite limited so far and have avoid US/UK style Quantitative Easing. No euro-printing so far.

There is a growing chance of this happening despite German rejection. The big question is: will it happen before German bonds are sold off as well?

What do you think?

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