ForexSpace.com - The ongoing and seemingly intractable political chaos in Greece combining with the rising tally for fixing Spain's banks further fueled fears this morning that the euro zone's debt crisis was in danger of spiraling in to some sort of free-fall. Top forex brokers and forex traders saw the European single currency close in on a three-month low as safe-haven German bonds rose. In fact, Germany paid record-low rates to get today’s bond auction away, selling €4.032bn of five year debt at average yields of 0.56 percent (compared with 0.8 percent at the last auction).

Demand outstripped supply by a ratio of 1.4 to one, (v.1.8 to one). Commenting, Annalisa Piazza at Newedge Strategy, said how all-in-all, “the auction was OK. Not exceptionally strong if compared with the previous three five-year auctions that registered a much more solid 1.8 bid/cover.”

Along with serious concerns about Europe's political landscape, unease about Spain's hugely indebted commercial banking system which drove its benchmark yields through the key 6 percent level, set financial sources into a febrile state late on Tuesday that the Spanish government would demand its banks raise around a further 35 billion euros in provisions against soured loans in their property portfolios.

Kathleen Brooks (pictured), research director with FOREX.com, notes how the Spanish bond market is pricing in the risk of the government needing to bail out its banking sector, hence why its bond yields are flying higher this morning, having risen nearly 25 basis points from yesterday, when – as Brooks says: “we noted how calm the European sovereign bond market seemed compared to equities and the FX market. So is the bond market now playing catch-up? Usually the bond market directs other asset classes,” says Brooks, “so if the increase in Spanish bond yields continues at this pace then this could be the “trigger” event that could cause EURUSD to convincingly break below 1.30 and for equities to fall below recent support levels.”

The chance of this scenario playing out depends largely on market reaction markets to the latest banking plan from the Spanish, expected to be released on Friday. Brooks opines that this could include an “enhanced re-capitalisation programme larger than the EU 50bn the Spanish government announced last year.”

Back then it suggested banks could raise some of their fresh capital needs via the capital markets; however with the Spanish stock market back at 2009 lows it is hard to see where the demand for a slice of the Spanish banking sector is going to come from. This leaves it up to the government or an EU entity to stump up the cash. As Brooks concludes: “If the government intervenes it would threaten the stability of the public finances (which are already fairly fragile) and could push Spain into requiring a bailout. Thus, it may be that the EU puts together some “banking sector” bailout, and creates a bad bank for Spanish assets. We will learn more on Friday.”

All of which, exacerbated by worries about the impact on the global economic outlook of softer growth in the United States, agglomerated to give rise to a broad retreat from risky assets, with world shares falling, oil prices down for a sixth straight session and the commodity-linked Aussie dollar hitting fresh lows. In AUD/USD, this morning saw 1.0050, thereby tempting some corporate buying demand, finding a key support zone on the way to parity. However, few experts and top forex brokers I’ve spoken to today expect such a move in the short-term, especially if risk sentiment continues to turn negative.

Rather, as has been the case for what seems like ages now, the market's immediate attention remains directed towards Athens, where the possibility – likelihood, even – of Greece being forced out of the single currency is once again occupying so many minds. As we see, Greek spreads are also widening to fresh post PSI high on reports in the German press that the Troika has cancelled its latest round of talks in Athens. The clock is now ticking on Syriza party leader, Alexis Tsipras, to form a coalition in next 48 hours. At the time of writing, Tsipras stated his expectation that Antonis Samaras of New Democracy and Evangelos Venizelos, the former finance minister who leads the Pasok party, to send a letter to the EU revoking their written pledges to implement austerity measures by the time he meets them today to discuss a government alliance. Both men rejected the request, with Samaras saying he was being asked "to put my signature to the destruction of Greece."

Drew Hillier. Editor