NEW YORK The euro rallied from a four-year low against the dollar on Monday, helped by a turnaround in stocks late in the session which temporarily offset fears that euro zone austerity measures could trigger a downturn in the region.
As the euro began to rise, investors who had bet against the single currency were also forced to buy back euros in order to cut their losses in what is known as a "short-squeeze."
Given the euro zone's debt problems, the euro has become a proxy for risk appetite, rising and falling in tandem with U.S. stocks.
The euro's correlation with the S&P 500 .SPX was at a robust 87 percent on Monday, the highest since February, according to Reuters data.
"We're seeing a little bit of a short-squeeze on the euro. Mondays tend to be a reversal day lately plus the fact that stocks have recovered and that's provided an impetus to exit euro shorts," said Brian Dolan, chief currency strategist, at Forex.com in Bedminster, New Jersey.
Dolan also believes the euro is likely to hit a short-term bottom between $1.2150-$1.2200 within the next few days and could rise back to the $1.26-$1.27 area.
"I think people are getting bored with euro weakness. You've got everybody and his brother talking about the euro That's a sure indication that the euro is due for a correction higher," he added.
In late New York trading, the euro changed hands 0.2 percent higher against the dollar at $1.2387. Earlier in the global session, the euro fell as low as $1.2234, according to electronic trading platform EBS, the lowest in more than four years.
Against the yen, the euro traded up 0.1 percent at 114.54 yen after falling to 112.47 in Asia trade. The dollar was last at 92.51 yen, flat from Friday's close.
The euro has fallen nearly 7 percent against the dollar this month, and is about percent 13.5 for the year, making it the worst-performing major currency so far in 2010.
Technical analysts said the next key support was at $1.2135, the 50 percent retracement of the rally from the all-time lows near 82 U.S. cents to record highs just above $1.60.
Overall, sentiment on the euro remained negative, analysts said, and many think this rise in the euro is short-lived.
MORE QUESTIONS THAN ANSWERS
A 750-billion euro ($1 trillion) bailout package from the European Union and the International Monetary Fund aimed at shoring up euro zone bond markets has done little to appease concerns Greece's debt crisis could spread to other similarly indebted countries such as Spain and Portugal.
"It's a package that raises more questions than answers and wouldn't necessarily alleviate the euro zone debt crisis," said John McCarthy, director of foreign exchange trading at ING Capital Markets in New York.
"We expect the euro to slip further as long as we remain in this lack of resolution phase in the euro zone. But it's not a straight line function and I'm sure we're going to see a bounce here and there."
European Central Bank policymaker Ewald Nowotny earlier said the fall in the currency was not a cause for concern, adding the exchange rate was in a "normal range" and there was no reason for hysteria about it.
However, Eurogroup Chairman Jean-Claude Juncker said on Monday he was worried about the pace of the euro's fall than the exchange rate itself.
The ECB on Monday bought 16.5 billion euros worth of bonds in the first week of its government debt buying program to help resolve the euro zone's debt crisis.
Analysts said widening euro zone problems had prompted a money market dollar liquidity shortage.
Meanwhile, data released on Friday showed speculative bets against the euro hit a record high in the week to May 11.
Sterling, meanwhile, slid to its lowest since March 2009 at $1.4249 before rising back to $1.4474, still down 0.4 percent on the day.
The pound was hit by data showing the past year's rise in British house prices may be cooling.