NEW YORK The euro fell from an early two-week high against the U.S. dollar on Friday as investors grew wary about the outcome of Greek debt negotiations ahead of the weekend despite growing expectations of a deal.
But so far this week, the euro has risen more than 2 percent, putting it on track for the biggest weekly advance since mid-October after Thursday's solid bond auctions in Spain and France whetted investors' risk appetite.
An initial agreement between Greece and its private creditors to reduce the country's huge debt load could come as soon as late Friday, sources familiar with the talks said. Any supposed agreement will be followed by technical talks over the weekend.
Analysts said the euro could stay supported in the short term despite Friday's drop as investors await word on the Greek debt talks.
"Over the past few days, the market has taken a more optimistic view of events. The hopes of a Greek agreement have helped, as has better economic data and a more positive, maybe even coordinated, spin by recent European Central Bank speakers," said Ken Dickson investment director at Standard Life Investments in Edinburgh, which has assets under management of $233 billion.
In late afternoon trading, the euro shed 0.3 percent to $1.2927, falling from a peak of $1.2986, according to Reuters data, when it stopped just shy of the key $1.30 level. However, it remained well above last week's 17-month low.
A positive outcome to the Greek talks is expected to boost the euro, although investors would remain wary about the risks of the region's debt crisis deteriorating further. Any negative news could see investors re-establish bearish bets.
"We continue to hold on to downside exposure in euro/dollar ... but at this point, we are looking more for a gradual structural weakening move than an imminent collapse," said Jens Nordvig, head of global currency strategy at Nomura Securities in New York.
He added that Nomura is not ruling out further gains in the euro before the downtrend in the currency pair resumes.
"Hence, we are staying away from short euro/dollar spot positions for the time being."
Against the yen, the euro dropped 0.5 percent to 99.50, off an earlier three-week high, but still comfortably above an 11-year low touched on January 16.
The euro has gained more than 2 percent against the yen this week, and was on track for its largest weekly advance since October.
Investors stacked up bets against the euro after ratings agency Standard & Poor's downgraded nine euro-zone countries, including France and Austria, late last Friday. Sentiment has since improved though further gains could be difficult.
The ratio of long to short positions in the euro/dollar stands at -1.58 as nearly 61 percent of traders are short, says DailyFX using client data. The ratio was at -2.24 as 69 percent of open positions were short on Thursday.
DailyFX noted on Thursday that short interest was at its highest since October 25, at which point the euro/dollar was trading at $1.3900 and was on its way above the $1.4000 mark.
"Although past performance is no guarantee of future results, such one-sided extremes can often come at major turning points," said David Rodriguez, quantitative strategist at DailyFX in New York.
CFTC data showed net short euro positions hit a record for the fourth straight week in the period ending January 17.
In addition to the risk of a messy Greek default, market players still see downside risks to the euro in coming months due to concerns that the euro zone's economy may slip into recession and limit progress toward fiscal consolidation in the region.
The euro was last little changed against the Swiss franc at 1.2084 Swiss francs.
Switzerland's central bank will keep the franc capped against the euro for an open-ended period of time and will enforce the ceiling with all available means, interim Chairman Thomas Jordan said.
The dollar index .DXY dipped 0.1 percent to 80.150, but off a two-week low of 79.999 hit earlier in the session.
The U.S. dollar fell 0.2 percent against the yen to 76.94.
(Reporting By Nick Olivari and Gertrude Chavez-Dreyfuss; Editing by Jan Paschal)