The euro fell against the safe-haven US dollar and Japanese yen on Wednesday as the eurozone'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 eurozone'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 eurozone sentiment could take the common currency as low as $1.34 in the near term. The euro was down 1.5 percent at $1.3628, having fallen to a session low of $1.36221 on trading platform EBS and on track for its biggest daily loss since October 31.
It pulled away from 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 as macro funds and leveraged investors stepped up selling. Support for the euro is seen at the November 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 1.5 percent lower on the day at 105.86, dropping below key support at its 55-day moving average which comes in at around 106.19 yen.
Traders said Japanese investors have in the past been big buyers of Italian debt and the decision to raise margins could see many unwind those positions, adding to the euro's woes. 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 analysts expect the euro to gradually lose ground as the currency bloc's debt crisis continues to defy policymakers' efforts to stall contagion and eurozone economic data highlight the region is heading towards a deep slowdown. "Its correlation with European stocks has been tight and if stocks break lower, we think the euro will start moving down. The (eurozone) PMIs are not looking good, more rate cuts are being factored and the crisis is deepening," Frost said.
In the options market, one-month EUR/USD implied volatilities rose 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. One-year risk reversals hit a record high of 4.45 in favour of euro puts, according to IFR.
The move away from the euro and the push towards the low risk and the high-liquidity of US dollar saw the dollar index rise more than 1 percent on the day to 77.477. The US dollar was flat against the Japanese yen at 77.62 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. The dollar rose 1 percent against the Swiss franc to 0.9047 francs.