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The Euro and Wednesday's Market Slide

The euro fell out of bed as it dropped below $1.30 to an 11-month low, setting off a cascade of sell stops. No real headline news.

Bear in mind, this is VERY THIN trading — that is likely the most important fact. A couple observations:

1) the Italians sold about 10.7 billion euros in short-term (6 month to 2 year) debt, but Italian debt is not doing so well post-auction: the Italian 10-year is back up to 6.93 percent. The obvious concern is that the auction tomorrow for long-dated maturities will not go off as well. There's much greater risk holding 10-year than 6-month maturities.

Who bought all this short-term debt? Not clear. The ECB is not supposed to be buying sovereign debt directly. It was likely Italian banks.

2) the ECB is expanding its balance sheet (rising to a record 2.73 trillion euros), no doubt due to the new 3-year loan facility.

3) the ECB loans out to the banks are collateralized with sovereign debt that is widening out so the liability to the banks is increasing.

4) European banks are parking a record 452 billion euros with the ECB rather than buy bonds or lend it out. This is likely an end-of-the-year phenomenon; banks are likely going to use this money to pay down their own debt, much of which is coming due in the first quarter. This is good news for bank balance sheets, but not good news for sovereign debt, since banks will likely be buying less of it than expected.

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