Watch the euro.
Yesterday while stocks in Europe and around the world rallied in relief on news of a $146 billion bailout for Greece, a falling euro signaled continued skepticism that the crisis was over.
That skepticism seems to be on the rise this morning. As of 9:00 a.m. in New York the euro had fallen $1.3064 against the U.S. dollar. That’s down from $1.3207 in New York yesterday and marks the lowest price for the euro in more than a year.
The decision by the European Central Bank to continue to accept Greek government bonds as collateral for bank loans even though they are now rated below investment grade—or more popularly called junk—seems to be weighing particularly heavily on the currency markets.
From the point of view of currency traders—and holders of euros in general—now that European Union politicians have abandoned what few shreds of fiscal credibility they had in a bailout deal that no one believes has really solved the euro zone’s debt problem, the European Central Bank is the last line of defense. Anything that the bank does to weaken its standards—such as accepting junk bonds as collateral—undermines belief in that line of defense just a little bit more.
The euro will be in for another round of selling if the bank comes to be seen not as the heir to the hard-nosed inflation fighting Deutsche Bank but as just another central bank willing to sacrifice long-term policy to the politics of the moment.