Rating agencies warned on Monday that last week's EU summit, viewed by some as a last chance to save the euro, did not go far enough in easing immediate concerns about the region's debt markets.
The euro fell as low as $1.3160, but climbed as far as $1.3206, in the Asian afternoon on shortcovering before steadying at $1.3192.
Net euro short positions totaled 95,814 contracts in the week through December 6, according to Commodity Futures Trading Commission data, and market participants said shorts likely increased in the wake of the disappointing summit.
The single currency could therefore continue to get the kind of short-term support it got on Tuesday, whenever investors take profits on or cover those positions.
"There are short positions built up in the euro now so a rise on short-covering is possible, but for the short term, for the coming week or so, a fall in the euro seems more likely unless there are any fresh developments about support for the euro zone," said Masafumi Yamamoto, chief FX strategist for Japan at Barclays Bank.
A break below Oct. 4's nadir of $1.3145 would take the euro back to depths not seen since mid-January.
A daily close below $1.3150 would add to bearish price momentum and expose $1.3050 as the next downside target, according to George Davis, chief technical analyst at RBC Dominion Securities. That level would be a 61.8 percent Fibonacci retracement of the June 2010-May 2011 advance.
MacNeil Curry, technical strategist at Bank of America/Merrill Lynch, dropped his bullish euro/dollar call and adopted a neutral view following the euro's drop below $1.3212.
"With the break of support, the next level of note is 1.3146. Through here would turn us negative, opening significant downside potential, targeting 1.2510," he said.
FALLING RISK APPETITE
Pressure on the euro and heightened risk aversion increased the greenback's safe-haven appeal and helped lift the dollar index to 79.651, its highest this month, before it eased back to 79.476.
The dollar index was above its weekly Ichimoku cloud top for the first time since September 2010.
The greenabck also edged up against the yen, rising as high as 77.97 at one stage before trading around 77.86.
The fall in risk appetite hurt commodity currencies, which suffered steep declines.
The Australian dollar shed more than 1 cent to a two-week low of $1.0030, before recovering as high as $1.0096, breaking through resistance at the base of its daily Ichimoku cloud at $1.0077 and approaching its 55-day moving average at $1.0120. The Aussie was last trading around $1.0083.
Support now lies at its 21-day moving average of $1.0047 and then at parity, followed by $0.9942, which would represent a 61.8 percent retracement of its November-December climb.
Later on Tuesday, the Federal Reserve will hold its final policy meeting of the year but it is not expected to take any action other than some finishing touches on its communication strategy. Many analysts expect the Fed to wait until a two-day meeting on Jan. 24-25 before launching any new initiatives.
Ahead of the Fed, investors are waiting for a closely watched survey of German analyst and investor sentiment, as well as US retail sales data.
Market liquidity has been thin ahead of year-end holidays, which could hurt demand in bond sales by Italy and Spain on Wednesday and Thursday. Weak results would add to pressure on the euro.
The ECB was seen buying short-dated Italian bonds on Monday but this failed to convince markets that the central bank is about to significantly step up its purchases beyond a reported weekly commitment of up to 20 billion euros.
Still, the ECB "has certainly eased market conditions" by lowering the quality of acceptable collateral and offering loans maturing in three years, said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co.
"There is also market talk surfacing about whether the ECB has another ploy up its sleeve by offering loans of such length," Wilkinson said in a research note.
While outright monetisation of government debt would go against the central bank's rules, the ECB could be facilitating institutional plugging of deficits, he said.
"With short-dated yields down at around 1 percent and an ability to lock in costs for up to three years, some are pointing to the arbitrage opportunity available," he said.
For example, Italy on Monday sold 7 billion euros worth of one-year bills at 5.95 percent, which Wilkinson called a "tremendous arbitrage opportunity to take advantage of, and one that the ECB might be turning a blind eye to despite the fact that it would be against the 'spirit of the treaty' to encourage the private sector to do openly what is officially banned".