Forex News – Euro sell-off continues for a third session on Italy debt woes

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The sell-off in the euro continues for a third straight session, tumbling further in the North American session. EURUSD is currently at 1.3551 at 15:00 GMT, losing 2.2 percent on the day so far. Increased risk aversion due to concerns about Europe’s worsening debt crisis sparked by a surge in Italy’s bond yields, pushed investors to unload the single currency.

Selling picked up after an overnight increase in margin requirements for banks that use Italian debt as collateral pushed Italian government bond yields above 7 percent, a level many investors fear is unsustainable.

Yields on 10-year Italian bonds hit as high as 7.4% Wednesday, a record high for the euro era, in the latest sign that investors are fast losing faith in the world’s third-biggest sovereign-bond market. Portugal , Greece and Ireland resorted to asking for a financial bailouts after their bond yields exceeded 7%, a level many market analysts consider unsustainable.

The investor exodus from Italian bonds, sparked by the dual political crises in Italy and Greece, raises the most dangerous scenario yet in the euro zone’s two-year-old debt crisis. Italy is much larger than Greece and Portugal and Ireland, all of which were given bailouts by the EFSF rescue fund.

However Italy’s debt is too large for the EFSF to bailout. With €1.9 trillion in government debt, Italy accounts for nearly one-quarter of all euro-zone public debt, and could prove too big for other European governments to save.

The instability of Italy’s political situation is decreasing market confidence levels. In short, a confidence issue could turn into a “liquidity issue.”

Reversing the capital flight could require both political change in Italy and massive international assistance.

If the mere announcement of a new government doesn’t stop the capital outflow, the EFSF are unlikely to meet Rome’s needs. Failure to halt the crisis could lead, in the worst case, to a liquidity crisis and consequently an Italian debt default that cripples all of Europe’s banks, plunging the region into a slump and causing havoc to the global financial system.