The euro rose on Tuesday as investors trimmed bets to sell the shared currency, but it was vulnerable to more selling on concerns that politicians on both sides of the Atlantic are failing to tackle huge debt burdens. Such worries, illustrated by the growing premiums markets priced in to offset the risk of holding debt issued by weak eurozone countries, have been supporting the dollar, which hovered near a six-week high against a basket of currencies.
Percieved riskier currencies regained some ground after coming under pressure during the previous session, but dollar funding strains continued to support the US currency as European banks scrambled to secure cash dollars. The euro rose nearly half a percent on the day to $1.3568. Demand from Mideast participants lifted the single currency from the day's low hit in Asia, but analysts said it would struggle to appreciate further.
"The big events in the US and Europe are still coming out as negative and providing a bearish backdrop for investors," said Ian Stannard, head of European FX strategy at Morgan Stanley. The dollar index slipped 0.2 percent on the day at 78.068, but stayed within reach of Monday's peak of 78.516, its highest level since October 10.
Investors had reached for the safety of the world's most liquid currency after a "super committee" of US lawmakers failed to agree on a deficit cutting plan. A jump in Spanish bond yields to their highest in 14 years at a short-term bill issue on Tuesday highlighted market concerns about the eurozone's ability to overcome its debt crisis although the jump was not unexpected and the euro showed little immediate reaction. Signs the dollar money market was seizing up added to investor concerns the spiralling eurozone debt crisis could pummel European banks.
Stress in the dollar money market showed no sign of abating after the three-month euro/dollar swap spread rose to 140 basis points on Monday, the highest level since late 2008. It was last around 138 basis points. Market players said speculation that the already huge bets made against the euro could lead to further bouts of short covering had helped support the single currency above a six-week low of $1.3421 hit last week. The dollar was little changed at 76.85 yen, while the Australian dollar pared heavy losses incurred on Monday. It was up 0.2 percent on the day at $0.9870 but was still below a support-turned-resistance level of around $0.9910, a 61.8 percent retracement of its October rally.