TOKYO: The euro regained some ground on Wednesday as short-term players covered short positions ahead of a European Central Bank policy meeting, following a steep fall against the Swiss franc and the dollar after Moody's slashed Portugal's credit rating to junk.
The single currency was lifted by stop-loss buying as well as broad weakness in the dollar, which fell prey to profit-taking after Tuesday's short squeeze with Asian central banks selling it while hedge funds liquidated their longs in dollar/yen.
While Portugal's downgrade reignited lingering fears about other highly indebted peripheral euro zone countries, a broad flight from risk was averted with stocks and commodities advancing and supporting the Australian and New Zealand dollars.
"The Portugal news doesn't really change fundamentals. That's why the market's reaction was limited to one day. If we were talking about Spain, now that would be a totally different story," said Koji Fukaya, director of global foreign exchange research at Credit Suisse Securities in Tokyo.
Some economists think Ireland may also need more support and worry Spain and Italy may be next in line for aid.
"We've had some event-selling in the euro from which the market is now recovering," said Fukaya.
Traders added the market has already fully priced-in a rate hike by the European Central Bank on Thursday, and that the euro's near-term outlook depends on whether ECB President Jean-Claude Trichet sounds hawkish or not.
Analyst said the euro will have a hard time eking out more long-term gains versus the greenback if Friday's US payrolls suggest the US economy is not doing as badly as feared and with yields on 10-year US Treasuries firmly above 3 percent.
These views were echoed by Minoru Shioiri, forex manager at Mitsubishi UFJ Morgan Stanley Securities in Tokyo.
"I tend to be more bullish about the dollar. The moves in the pair will likely be determined by news on the US side rather than by the possible rate hike by the ECB -- if payrolls are strong, we may see the euro edging towards $1.40 long-term," said Shioiri.
He added, however, that the euro is likely to trade between 1.40 and 1.45 at least until problems related to the US debt ceiling are fully resolved towards the beginning of August.
The European single currency popped above the top of the Ichimoku cloud, nudging 0.2 percent higher to $1.4460 , after dropping about a full cent to a low around $1.4395 on Tuesday.
The session low, a Fibonacci support representing a 38.2 percent retracement of the June 27 to July 4 rally, is likely to hold for now. The next support level is seen at $1.4339, a 50 percent retracement.
Underscoring caution ahead of the ECB and US payrolls, the euro hovered near its previous day's low around 1.2093 Swiss francs , hit after Moody's cut Portugal's credit rating by four notches to Ba2, saying there is great risk the country will need a second round of official financing before it can return to capital markets.
Traders said the break of support around 1.2180 francs triggered more selling in a move that unwound about a third of last week's 4.3 percent rally. It last stood at 1.2130, well below Monday's high of 1.2349.
UNDER A CLOUD
Broad weakness in the greenback pushed the dollar index , which tracks the greenback's performance against a basket of major currencies, firmly below resistance on its Ichimoku cloud base to 74.499, but still well above one-month lows hit on Monday at 74.133.
The dollar also softened versus the yen, shedding 0.3 percent to as low as 80.81 yen , as hedge funds liquidated some of their longs and exporters sold, with loss-cut selling triggered around 80.90-80.80 yen.
The pair continued to frustrate dealers as it kept trading within the well-trodden range roughly between 79.80-81.30.
Meanwhile, commodity currencies like the Australian dollar held up pretty well despite Portugal's downgrade. Talk of bids from Asian central banks and local exporters around $1.0660/70 for the Aussie appeared to be providing a floor.
The Aussie was up 0.4 percent at $1.0725, off Tuesday's session low around $1.0664. It came under pressure in the previous session following less upbeat comments from the Reserve Bank of Australia.
"Our core view is one more tightening remains on the cards late this year, but the data that flows under the bridge between now and then will be critical," said analysts at St. George Bank.
"Whereas at the start of this year, the risk was that more than one tightening would be needed. Now the growing risk is that no tightening will be needed this year.
COPYRIGHT REUTERS, 2011
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