Euro nears 11-month low, all eyes on Italy's bond sale
Fed offers no respite, euro jitters unabated.
The euro wallowed near 11-month lows against the dollar on Wednesday and crept close to an option barrier whose break could rapidly speed up its decline, with an Italian bond sale coming into focus later in the day.
After the Federal Reserve refrained as expected from boosting its easing programme at a meeting on Tuesday, euro bears felt free to end weeks of deadlock and pummelled the currency to as low as $1.3009, a level not seen since mid-January.
Piling more pressure on the embattled currency, German leader Angela Merkel has rejected any suggestion of raising the funding limit of Europe's future bailout fund, the European Stability Mechanism, sources said. A spike in Italian bond yields above 7 percent for the first time in nearly two weeks also soured the mood.
In Asia, the euro licked its wounds at $1.3030, with large bids a bit above $1.3000 to hedge an option barrier at that level preventing further selling. Traders mentioned one more barrier at $1.2980 and said if both gave way the euro's decline might dramatically pick up steam.
"There is some buying on the dip and option-related bids stabilising the euro today, but the bearish trend is by no means over. By the beginning of 2012 it's likely to drop to around $1.25," said Koji Fukaya, chief FX strategist at Credit Suisse.
The common currency has held up remarkably well despite extreme volatility in the euro zone bond market, but the break of a stalwart support point around $1.32 has raised the risk of a quick move to the 2011 trough hit on Jan. 10 at $1.2860.
A trader for a Tokyo bank said leveraged funds are partly to blame for the decline, having been dumping the euro since late last week. He said their selling was concentrated around the start of London trading and the funds appeared to be enlarging a short position and selling most aggressively when the euro came under pressure.
The ESM, which will replace the current EFSF bailout fund and should come into effect from the middle of next year, will have an effective lending capacity of 500 billion euros. European Council chief Herman Van Rompuy said on Tuesday a review of whether funding was adequate would be completed in March.
"The credibility of the European response is very much in doubt, driving EUR/USD lower," said Kit Juckes, head of foreign exchange research at Societe Generale.
"European institutions continue to hammer the point of what they are not willing to do. The market is driving down the point of how little they are willing to risk in a deleveraged financial system, and this ahead of the holidays."
Judging from the euro's dip the previous day below the lower Bollinger Band - a short-term indicator that an asset is oversold - technical levels do not bode well for it either, traders say.
The currency has now clawed back above the lower Bollinger Band, which now comes in at around $1.3027. The last time the euro broke below the band, in early September, it ended up spending much of the next month trading below it.
ALL EYES ON ITALY
The market's focus is turning to an Italian bond sale later on Wednesday, and another by Spain on Thursday. The danger of a credit ratings downgrade may keep borrowing costs punishingly high for both, traders said.
"The euro traded with scant reference to euro zone bond developments on Tuesday, but that does not mean a good, bad or ugly auction today will not be a source of significant FX volatility on Wednesday," BNP Paribas analysts said.
Markets were braced for a possible mass downgrade of eurozone countries, which would deepen the region's debt crisis, after last week's key summit offered no hopes for an immediate resolution. A downgrade for France could come any day.
The Fed also highlighted the turmoil in Europe as a big risk to the U.S. economy, keeping intact an easing bias.
The euro's woes saw the dollar index power to an 11-month high of 80.395. It last eased to 80.277, but stood well clear of a major support at the top of the weekly Ichimoku cloud at 79.50. The greenback held steady against the yen at 77.97 having briefly popped above the 78 yen line for the first time since December 5.
Commodity currencies were under mild pressure. The Australian dollar hovered around parity versus the dollar. It last stood at $1.0005, with support seen at $0.9938, a 61.8 percent retracement of the November 23 to December 8 rally.
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