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Traders remain wary about the still fragile situation in Europe. Italy’s borrowing costs continued rising on bond markets on Thursday, meaning the euro zone’s third-biggest economic player may struggle to borrow on the private market and finance itself this year. The country’s 10-year note recently yielded 7.16%, a level that is seen as unsustainable by many analysts. Fitch Ratings also slashed Hungary’s credit rating by one notch to “BB+” from “BBB-” and warned of the potential for more cuts down the line. Fitch is now in line with Standard & Poor’s and Moody’s Investor Service, both of whom have the country in junk territory. The recent enthusiasm over the positive U.S. data may be “tempered with the familiar worries about Europe moving back to the fore in recent days, with some taking the view that the payrolls result is only going to provide a slight diversion of attention before caution returns. The economy tacked on 200,000 jobs in December as the unemployment rate nudged lower to 8.5% from a revised 8.7% in November, according to a report from the Labor Department. The jobless rate is now at its lowest level since February 2009. In the past year, the economy has added 1.6 million jobs, the report said. The euro has struggled, recently hitting the lowest level since September 2010 in a sign of market worries about the currency bloc. The single currency recently fell 0.57% to $1.2716, while the U.S. dollar rose 0.46% against a basket of six world currencies. Rumors on FX Market preparing for a Break-up of Euro and new all time high of bank deposits in ECB.

Rumors on FX Market preparing for a Break-up of Euro

I came across this report from Reuters and thought I shared this with you, because major news channels are not talking about this. This is an eye opener.

Many of the industry’s big FX banks, clearing houses and trading platforms say they are looking at ways to ensure their systems can quickly deal with any change in the composition in the euro, the world’s most traded currency after the dollar. Such moves would not only trigger deep economic and credit risks, the unprepared could face the nightmare of having to quote and trade euro-replacement currencies in the $4 trillion a day FX market. Some institutions say they have been preparing for a possible break-up since mid-2010, when Greek default fears flared.

Banks had years — and more money — to prepare for the euro’s launch, but the 2007-2008 credit crisis has left many in a weaker position to deal with a break-up, which could happen suddenly to minimise damage to the value of assets issued by an exiting country. FX participants acknowledge the difficulty of preparing for an event which could be kept secret until the last minute.

Industry experts say smaller institutions are under-equipped to deal with the initial disruptions to trade that could result should a country leave the euro, while adding that most big banks’ FX desks are expected to weather the transition. If Greece, for example, left the euro, banks would need to update dealing systems to trade a “new drachma” against other currencies — from the dollar to the Swiss franc on a spot and forward basis. The process may be more complicated than reviving dormant trading pairs, such as drachma/dollar, as the old trading software might be incompatible with modern systems.

Hungary Rated Junk Status

As I have been saying all along, Hungary WILL be the next show to drop in Europe. The Hungarian currency Forint is pegged to the Swiss Franc. Hungary’s currency, the forint, fell to all-time lows against the euro Wednesday amid growing uncertainty over a new financial aid deal for financial aid with the International Monetary Fund and concerns over the government’s economic policies.

Hungary is seeking a financial “safety net” from the IMF and the European Union, but preliminary talks ended prematurely in December as the government pushed ahead with new laws seen as infringing on the independence of the National Bank of Hungary. Talks with the IMF are due to restart next week in Washington.

Investors are also skeptical about the sustainability of the government’s economic policy, which has drawn on “unorthodox” methods to ensure that the state budget deficit stays within EU guidelines. Under the previous, Socialist-led government, Hungary received a bailout of euro20 billion ($26 billion) in 2008 as investors shied away from buying Hungarian debt. A similar situation could be playing out now, with yields on long-term Hungarian bonds rising to above 10 percent this week and the price of insuring Hungarian debt escalating to new highs.

Fitch became the third ratings agency to downgrade Hungary’s debt to “junk” status on Friday, invoking further deterioration in the country’s fiscal and external financing and growth outlook and the government’s “unorthodox” economic policies. Banks in euro zone countries have significant exposure to Hungary, with Austrian financial institutions having more than $40 billion in the country, Italian banks nearly $25 billion, German banks a little over $20 billion and Belgian banks over $15 billion, according to figures by the Bank of International Settlements and ING estimates.

In November, Moody’s became the first agency to downgrade Hungary to below investment grade, citing a weak economic outlook and lack of predictability as the main reasons. In December, S&P cut the country’s rating to “junk” citing changes to the constitution that undermined the independence of the central bank as part of the reason for the downgrade, as well as rising unpredictability in the country’s economic policies.

Since coming to power in 2010, Orban’s government took over private pension funds, set a fixed exchange rate for loans in foreign currency taken during the boom years before 2008 — forcing banks to take the losses due to the national currency’s depreciation — and imposed the biggest tax in Europe on banks, sparking investors’ protests. Fitch said the government’s policies, popular with voters but which have prompted foreign investors’ fury and have attracted international criticism, were part of the reason for the downgrade.

Overnight Deposits Hit Another All Time High: Are Europe Capital Markets Freezing

Commercial banks’ overnight deposits at the European Central Bank hit a new record high of 455 billion euros ($582.3 billion), data showed on Friday, indicating banks prefer the safety of the central bank to higher rates they could get by lending to each other. At the same time, emergency overnight borrowing fell to 1.861 billion euros ($2.382 billion), the lowest since Nov 28. That eased some concerns about banks scrambling desperately for funds and having to pay an interest rate of 1.75 percent instead of the 1.0 percent the ECB charges in its regular refinancing operations. The ECB pays 0.25 percent interest for overnight deposits, well below the 0.369 percent for which banks could lend out their spare cash on interbank markets. Banks are awash with cash after taking an unprecedented 489 billion euros ($625.8 billion) in the ECB’s first-ever three-year liquidity operation late last month, and are mulling what to do with the money in the longer term. The liquidity operation was designed to underpin banks’ finances and hopefully repair some confidence in the sector, but the sovereign debt crisis means many institutions still lack enough trust to lend to each other and prefer to stash their money at the ECB. The 455.299 billion euros ($582.79 billion) in deposits topped the previous record high of 453.181 billion ($580 billion) euros reached on Wednesday. With total ECB lending at 685 billion euros ($876.8 billion), banks are returning two-thirds of the money back to the central bank.

The more banks give back to the ECB is an indication that there is less trust in other institutions. Repeat of 2008 run from the banks in the US, which shuttered financing for businesses. The ECB is worried that the euro zone could see a credit crunch and has responded by flooding the money market with cheap cash, offering banks unlimited funds in maturities ranging from one week to three years at a rate of 1.0 percent. But is it enough?