EUR Nears Three-Month Low, BOJ Upcoming

The euro plunged Monday and sentiment wilted on talk of selective Greek default and an Italian debt crisis. EUR/USD fell more than 2 cents to close narrowly above a 2-month low. The upcoming sessions features the Bank of Japan`s interest rate decision.

USD, JPY and CHF were bunched near the top of the G10 leaderboard with EUR and NZD trailing. The S&P 500 fell 1.8% to 1319.

Several reports combined to crush the euro: 1) The FT reported that some European leaders would consider letting Athens default on some of its debt. 2) German newspaper Die Welt reported that the size of the EU bailout fund may need to be doubled to 1.5 trillion euros. 3) Rumours of sovereign fiscal strain in Italy and Italian banks.

We believe PROBLEMS IN ITALY HAVE BEEN OVERSTATED. On June 17, Moody`s said it may downgrade Italy`s Aa2 rating in the next 90 days. We have to envision that downgrades from Moody`s have caused an irrational rush to the exit because we fail to see significant risks from Italian sovereign debt. The nation is in nowhere near the same predicament as Greece, Portugal, Ireland or even Spain. There is talk of banking problems but we can`t imagine where they are arising from. Italian banks are extremely unlikely to be holding large-scale positions in periphery debt and domestic loans are performing.

Technically, the euro`s low from May 23 of 1.3969 (a three month low) is critical. Today the pair fell as low as 1.3985 but rebounded to close above 1.40. This is still the lowest close since late March.

Sentiment may continue to slide after ALCOA EARNINGS (ex-itesms) of 32-cents per share missed the 33-cent consensus. We note that revenue was higher than expected and initial comments from management did not cast doubts about the economic recovery.

The lone economic data point Monday was Canadian housing starts. They advanced to 197K from 194K and better than the 182K expected. The Bank of Canada also unveiled an optimistic and hawkish suvey of businesses. A RECORD LOW of 4% of firms surveyed expected to lay off worker in the coming year, while 57% expect to hire additional workers. the number of firms anticipating an inflation rate above 2% increased to 80%, compared to 46% six months ago.

The market continues to underprice the risk of a SURPRISE BANK OF CANADA RATE HIKE, or the possibility of a hawkish statement. None of Canada`s 12 primary dealers are forecasting a rate hike on June 19 and only half call for a rise at the subsequent meeting in Sept. Without question, the BOC would be hiking rates if the situations in Europe and the United States had unfolded more closely to expectations. Given the gyrations in sentiment, long CAD positions may be best expressed against fellow commodity currencies. Unfortunately, this doesn`t hedge out oil price volatility as crude fell 1.1% on Monday.

The upcoming session will be busy in the Asia-Pacific region. The highlight in Japan`s MONETARY POLICY DECISION. There is no set time but it`s generally released around 0200 GMT. Rates are assured to remain at 0.10%. The three meetings so far in the wake of the disaster have included further incremental QE and/or lending programs but no further action is expected here, although Nishimura is likely to renew his call for more asset purchases.

Earlier, at 2350 GMT, Japan releases its corporate goods price index and teritary (service) industry activity measure. At 0130 the National Australian Bank releases its measure of business confidence. The prior reading was +6.