FOR the past several months, the euro-dollar has been like the Terminator. Nothing could slow down its progress as markets ignored all sovereign debt problems in the periphery and focused only on yield differentials. A hawkish European Central Bank (ECB), which raised rates by 25 basis points last month, stood in sharp contrast to America’s dovish Federal Reserve, which showed no hurry to tighten monetary policy anytime soon. The euro therefore continued to defy sceptics and rose steadily, setting fresh yearly highs on a near daily basis.

Until this week. This week, the euro-dollar suddenly became like Blanche Dubois, swooning at the very mention of the word “restructuring”. Not even the historic announcement that the Standard and Poor’s ratings agency cut its outlook for US sovereign debt from stable to negative, could keep the euro-dollar bid for more than a few minutes as the single currency quickly reversed its gains and continued to tumble.

Up to now, the euro has been able to shrug off the prospect of fresh bailouts as the market assumed that the European Financial Stability Facility would provide the necessary support to deal with the issue. However, the idea of Greek debt restructuring triggered a paroxysm of selling in the pair on fears that it would damage the EU’s financial system.

Any restructuring of Greek debt would inevitably involve haircuts on the amount outstanding, which in turn could decimate the balance sheets of major European banks, especially those of France, who reportedly hold significant inventory of Greek bonds. Little wonder then that French Finance Minister Christine Lagarde recently noted that “there is no discussion about debt restructuring as far as Greece is concerned.” Any move by Greece to restructure its debt could also create a domino effect: Ireland and possibly Portugal could follow suit, creating massive instability in the monetary union.

For the first time this year, euro-dollar appears vulnerable, as the problems in the periphery economies threaten to fragment the union. For now $1.4000 should serve as support, but the pair will have a hard time clearing $1.4500 highs unless the restructuring problem is addressed.