December 16, 2011 / 7:20 AM / 8 years ago

FOREX-Euro slide pauses but debt jitters persist

* Euro off 11-mth low on short-covering; still down 2.5% on wk

* Aussie, Kiwi recoup some losses as risk in favour

* EUR/USD 1-mth implied vols slump to 3-1/2 mth low

* But danger of ratings downgrade keeps markets cautious

* Swiss franc holds gains after SNB leaves cap intact

By Antoni Slodkowski

TOKYO, Dec 16 (Reuters) - The euro was poised to end its worst week in about three months on an upbeat note, taking heart from light short-covering in most riskier assets on Friday on the back of a well-bid Spanish bond sale and solid U.S. economic data.

But the mood remained brittle with possible cuts in the credit ratings of euro zone countries looming after a key EU summit last week offered little respite to turbulent euro zone bond markets and cash-starved European banks.

This yanked the legs from under the currency that had until then remained surprisingly resilient, dragging it 2.7 percent down on the week — the biggest drop since early September — and pushing yields on 10-year Italian bonds above 7 percent for the first time in two weeks.

On Friday, the euro was supported at $1.3028, coming off an 11-month low of $1.2945 hit earlier in the week. Thursday’s trading range for the euro was well within its band from Wednesday, suggesting its downside momentum has waned — for now.

“My sense is that the market is satisfied, having driven the euro below the important $1.30 support level earlier this week. But most people are thinking it’s going to hit $1.25 within the January-March period,” said Michiyoshi Kato, a senior trader at Mizuho Coporate Bank.

Kato said the euro is vulnerable as the risk of downgrades looms large for the region and investors fear some states may develop cold feet with regard to the proposals on a tighter fiscal regime that were the centerpiece of the summit.

“France is the biggest worry. The spread on its bond yields versus German Bunds has widened since the beginning of the crisis and if it loses its triple A credit rating, the crisis may start engulfing the euro zone core.”

At one point the euro climbed as high as $1.3045 on dip-buying from hedge funds, but it stalled ahead of a layer of offers at $1.3050-60, placed below moderate resistance around $1.3065 — a 38.2 percent retracement of its Dec. 8-14 slump.

“S&P’s negative credit watch continues to hang over the euro zone bond market and negotiations on the Greek PSI (debt swap talks) are far from reaching a positive conclusion,” Luigi Speranza, an analyst at BNP Paribas, wrote in a client note.

“Hence we are left with the impression that market pressure will have to intensify in order to trigger further policy steps that could then set the basis for a more enduring stabilisation of the euro zone bond market.”

IMPLIED VOLS SLUMP

Markets will also be keeping an eye on a confidence vote in the Italian parliament later in the day to speed up approval of a 33-billion euro ($43 billion) austerity package.

Looking beyond the New Year, the euro area faces its next potential crunch point in mid-January when Italy has to start issuing tens of billions of euros in bonds towards a 2012 total of 340 billion euros needed to roll over maturing debt.

In the options market, one-month euro/dollar implied volatilities hit a 3-1/2-month low, coming further off elevated levels — seen by some as overpriced — that prevailed throughout the latter part of the year.

Option traders attributed the decline in volatility to many institutions closing their books ahead of Christmas holidays, rather than to reduced anxiety about the euro zone debt crisis.

“Also vols were too rich anyway — there was too much risk premium. The time decay that people were paying was too much, so we’re seeing a complete liquidation at the moment,” said an option trader for a European bank.

The pair’s implied volatility is now trading below its 50- and 100-day moving averages. It last stood at 12.70 percent — its lowest level since early September.

The euro nursed heavy losses against the Swiss franc after the Swiss National Bank held its cap on the franc at 1.20 per euro, knocking back speculation that it might try to deter investors further from seeking safety in the currency.

The common currency fell more than 1 percent to a six-week low around 1.2215 francs, before steadying at 1.2233 francs. The dollar shed more than 1 percent to 0.9388 francs , retreating from a 10-month peak of 0.9548.

The bounce in the euro saw the dollar index fall 0.4 percent to 80.20, off an 11-month high of 80.730 set on Wednesday. The index, however, remained well above resistance at the top of the Ichimoku cloud on the weekly chart, which came in at 79.56.

Commodity currencies received a solid fillip from a broadly softer dollar, dip-buying and stronger bourses with the Australian dollar popping back to $0.9967, returning from a two-week low of $0.9862. It shied away from tackling immediate resistance at Thursday’s high of $0.9990.

The New Zealand dollar was also well bid, recouping most of the previous day’s losses. It added 0.8 percent to $0.7590.

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