Markets are expected to remain choppy ahead of a European Union Leaders Summit which will begin a two-day meeting on long-term plans for fiscal and banking union on Thursday.

Last week, weaker-than-expected manufacturing PMI figures from the eurozone and Spain’s increasing borrowing costs were the catalyst of a free fall. The yield on Spanish 5-year bonds jumped to 6%, the yield on the 3-year bonds climbed to 5.5% and the yield on the 2-year bonds rose to 4.7%.

Meanwhile the FOMC maintained rates unchanged at historical low of 0.25% as widely expected and announced to expand the Operation Twist program by $267b to drive down long-term interest rates and make broader financial conditions more accommodative. The original $400b Operation Twist program, which was announced last September, will expire at the end of this month. Forex market reacted with disappointment after hopes of a third round of QE were dashed.

Europe is facing much greater challenges and the forex market won’t be optimistic unless policy makers produce a big surprise.

Rising borrowing costs in Spain renewed fears that Europe’s debt crisis is deepening. It is hard to see that the European developments are turning in a very positive direction.

EUR Chart

According to data from the Commodity Futures Trading Commission released on Friday, currency speculators pared their bets in favor of the U.S. dollar in the latest week. This is the second consecutive week that speculative traders continued to cover their short EUR positions. CFTC’s data also showed that traders decreased their open short CHF position by 79% from a week earlier to reach a net of $925 million. They also increased their open long JPY position by 24% to reach a net of $2.4 billion.

GBP Chart
CHF Chart
JPY Chart