LONDON: The euro fell against the safe-haven US dollar and Japanese yen on Wednesday as the euro zone's escalating debt crisis saw investors such as macro funds step up sales of the single currency after Italy's 10-year bond yield hit 7 percent.
The swift rise in bond yields prompted Paris-based clearing house LCH.Clearnet SA to raise the margin call on Italian bonds this morning, effectively driving the cost of using Italy's debt to raise funds higher.
Italian bond yields subsequently rose beyond 7 percent, breaking the closely-watched level which economists have long flagged as unsustainable for the euro zone's largest government bond market.
"Euro/dollar looks incredibly vulnerable at the moment. Everyone has concluded that the only buyer of Italian debt is the ECB... you need a much larger risk premium in the euro and it's not clear where this is going to end," said Chris Turner, head of foreign exchange strategy at ING.
Turner said the worsening euro zone sentiment could take the common currency as low as $1.34 in the near term.
The euro sank to a session low of $1.36545 on EBS, off a high of $1.3860 seen in early trade, triggering stops on the way down and breaking through reported option barriers at $1.3750 and $1.3700.
Support for the euro was seen at the Nov. 1 low of $1.3608.
The single currency also fell 1 percent versus the Japanese yen as investors preferred safe-haven currencies. The euro traded 1.18 percent lower on the day at 106.25 .
MORE EURO WEAKNESS
Uncertainty over how Italy would form a new government after Italy's Prime Minister Silvio Berlusconi said he would resign after passing urgent budget reforms was likely to weigh on the euro in the medium term, analysts said. Greece's struggle to form a government added to the unclear outlook.
Many investors and analysts point to a weaker euro over the medium term as the currency-bloc's debt crisis continues to defy policymakers' efforts to stall contagion.
"We think the euro will drift lower to $1.35 in the near term," said Stuart Frost head of absolute returns and currency at RWC Partners.
"Its correlation with European stocks has been tight and if stocks break lower, we think the euro will start moving down. The (euro zone) PMIs are not looking good, more rate cuts are being factored and the crisis is deepening," Frost who oversees a $50 million currency fund said.
In the options market, one-month EUR/USD implied volatilities roses to 14.8 percent , reversing a slide to 14.35 pct in earlier trade, as spot euro fell.
One-month 25-delta risk reversals rose to around 3.75 in favour of euro puts, closing in on a record high of 4.0 hit in September, suggesting the options market remains skewed to euro weakness.
The push towards the low risk and high-liquidity of US dollars saw the dollar index rise more than 1 percent on the day to 77.36.
The US dollar was steady against the Japanese yen at 77.70 with traders cited talk of an option barrier at 77.50 with Japanese bids lined up from 77.25 yen to 77.50 yen.
The euro also fell versus the safe-haven Swiss franc, reaching a low of 1.23050 francs. Against the dollar the Swiss franc was lower at 0.9018 francs.
Copyright Reuters, 2011
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