Euro on Defensive

European news today has been somewhat disappointing and this lead investors back into the dollar. The retail PMI fell below the 50 boom/bust level in Aug (49.7 vs 52.4 in July), while the EMU Sentiment Index came in at 101.8, as expected and a modest improvement over the 101.1 reading in July (was 101.3).   Apparently largely based on recent comments from BBK’s Weber, who still looks to have the inside track to replace Trichet next year, the Financial Times is playing up the likelihood that at this week’s meeting the ECB announces it will extend its extraordinary liquidity provisions into next year.  The shorter duration operations (1 week and 1 month) do not appear very controversial.  Extending the 3-month facility is somewhat more debatable, but also seems reasonable. Note that the ECB had cautioned that the EMU rebound would likely peak in Q2 and downside risks reemerge in late H2.   In recent weeks, the market has turned less sanguine toward EMU.  This month has seen a record monthly rise in credit-default swaps for Ireland, Italy and Spain.  CDS prices in Portugal rose this month by the most since April, and in Greece the most since June.   While ECB officials may have succeeded in easing the liquidity crisis earlier this year, there remains elevated concerns that solvency issues have not been resolved and the slower growth (in Europe and the world) exacerbates these concerns.   Another threat exists for core EMU members, like Austria and Belgium, in the form of eastern and central European exposure.  Harvard economist Rogoff warned that several eastern European countries may have to restructure their debt.  He specifically cited Ukraine, Romania and Hungary as “potential wobblers”.   While there was little immediate market reaction to the comments, this issue has potential to re-emerge. As the peripheral bond markets continue to struggle, the Euro has moved on the defensive.  The EUR/USD is stuck between support and resistance and waiting for a impetus for direction, although the downward pressure remains likely to continue.