THERE is no doubt that the currency market is now at the mercy of the credit market. Fears about the growing contagion in the Eurozone have sent euro-dollar to fresh three month lows at the start of this week’s trade, with the pair dropping below $1.3850 in yesterday’s chaotic market open. Italy has become the next target of the shorts, with yields on 10-year bonds rising well above the 5 per cent level, while credit default swaps on Italian sovereign debt were trading at a record wide spread.

The crisis in the Eurozone has now moved from the narrow periphery of Greece, Ireland and Portugal to the broader periphery of Italy and Spain. There is a risk that the selling in both the credit and the currency markets could turn into an avalanche, swamping officials’ ability to deal with the problem. Eurozone authorities are slowly beginning to realize that the market views the situation as a solvency rather than as a liquidity problem.

Despite the relentless selling pressure, euro-dollar managed to retake the key $1.4000 figure in yesterday’s North American trade on rumors of European Central Bank buying. However, any attempts by monetary officials to stabilise the market are likely to have only minimal impact in the long run as credit market concerns continue to weigh. This week’s sovereign debt auctions as well as bank stress tests due Friday will be the main barometers of investor confidence in euro-dollar and unless Eurozone officials are able to put forth a credible plan to backstop the sovereign debt, $1.4000 will cap any short covering rally.

The problem with the euro is that it is a currency without a country. Its confederate nature is beginning to hurt the whole project, as shorts simply hunt for the next weak link in the chain, forcing Eurozone officials into a perpetual cycle of bailouts. For the euro to survive as a viable currency, the European Union will have to go to a Eurobond format in order to avoid this endless game of selling the weakest credit.