* Short-covering, carry trade unwinds boost euro
* Japanese margin traders active buyers of Aussie/yen
* Low market liquidity exacerbates moves
* Euro up about 2 pct on week, Aussie slides 6 pct
By Masayuki Kitano
TOKYO, May 21 The euro surged for a third straight day on Friday as market players unwound more short positions in the single currency, while the battered Australian dollar jumped on a wave of buying by investors and Japanese retail traders.
After slumping to a four-year low earlier this week, the euro has rallied back on a flurry of short-covering by hedge funds and other short-term traders as well as fund repatriation by Eur 536870913 1869636961
The fears about the euro zone's future have rattled investors all month and sparked some of the worst currency market volatility this week since the severe market swings in the aftermath of the Lehman Brothers collapse.
Investors have scrambled to close out positions across markets, resulting in big short-covering in the euro and heavy selling of the higher-yielding Australian dollar that had been used as a proxy for Asia's stronger economic performance.
The rush for the exits has spooked other market players from trading actively, resulting in choppy and illiquid markets and more intraday turbulence. Implied volatility across currencies and stocks has shot higher.
"What has been happening over the past couple of days is position unwinding on a global scale," said Akira Hoshino, chief manager at Bank of Tokyo-Mitsubishi UFJ's foreign exchange trading department. "The euro, dollar and the yen have all become currencies used in the carry trade, so money is returning back to those currencies."
The euro climbed 1 percent to $1.2612 EUR=, pulling away from a four-year trough of $1.2143 hit earlier in the week.
The euro rose roughly 1.5 percent versus the yen to 113.62 yen EURJPY=R, rebounding from an 8-½ year low of 109.47 struck the previous day. The euro also rallied more than 1 percent against the Swiss franc EURCHF=R on stop-loss buying.
"The impact spilled over into various places and led to moves to cut losses in euro/Swiss franc, euro/Aussie or sterling/Aussie," said Minoru Shioiri, chief FX trading manager at Mitsubishi UFJ Morgan Stanley Securities.
In a sign that some investors were unwinding euro carry trades, the euro has surged nearly 8 percent over the past three days against the Australian dollar EURAUD=R.
Shorting the euro against the Aussie had been one of the more popular trades in currencies for macro hedge funds making bets on relative economic performance, and hedge funds were seen as 1952998688 main culprits unwinding those positions, traders said.
Even as the euro surged against the dollar and the yen, the single currency gave back some ground against the Australian dollar, which spiked higher in a volatile session.
The Australian dollar slid initially on loss-cut selling against the yen by Japanese retail margin traders, but later rebounded sharply.
After the initial flurry of loss-cut selling abated, the margin traders were detected actively buying the Australian dollar on dips, traders said.
"Retail investors are buying Aussie/yen quite a bit," said a trader for a major Japanese brokerage house.
"It's their typical trading pattern. They see how far the Aussie has fallen and are buying, seemingly without any other particular reason," the trader added.
The Australian dollar slumped to a 10-month low near 71.90 yen AUDJPY=R in early Asian trading on Friday but later jumped about 5 percent from that low to a high near 75.50 yen.
The Aussie was up 2 percent at $0.8302 AUD=D4 after surging back to $0.8373. The move up was on lower volumes on Reuters Matching compared with the past few days, suggesting that illiquid markets were contributing to the outsized moves.
The Aussie was still down 6 percent on the week, but a weekly close above the $0.8110 level -- the 38.2 percent retracement of the rise from the 2008 lows to the 2009 peak -- would help give it near-term support.
"Volatility is just very high," said Bank of Tokyo-Mitsubishi's Hoshino.
Market players said the Australian dollar was lifted partly by talk that the Reserve Bank of Australia was intervening in the market to support the Australian dollar. The RBA said that it did not comment on market moves.
The RBA intervenes when it perceives a lack of liquidity causing disorderly moves as in late 2008, but traders did not think conditions had yet become bad enough for them to step in.
The dollar rose 0.5 percent against the yen to 90.10 yen JPY=, getting some support from dollar buying by Japanese importers, market players said.
The market showed little reaction after the Bank of Japan fleshed out a new loan scheme aimed at encouraging commercial banks to lend more to industries with growth potential. [ID:nTKZ006436] (Additional reporting by Anirban Nag in Sydney, Rika Otsuka and Kaori Kaneko in Tokyo and Reuters FX analyst Rick Lloyd in Singapore)