FOREX-Euro bounces from 3-wk low; dollar at 8-wk high vs yen




The euro outperformed the dollar for the first time in four days on Tuesday, bouncing from a three-week low as investors' appetite for risk improved, but gains could be fleeting as technical factors point to losses.

The euro rose above the pivotal level of $1.35 and traded off a 3-week low of $1.3428 in the overnight session, with options expirations noted at $1.3500. The euro faces obstacles from several directions, however, with sovereign debt risk and interest rate differentials working decidedly against the single currency.

In early New York trading the euro EUR= was up 0.3 percent against the dollar at $1.3522 after breaking its 100-day moving average at $1.3541.

Camilla Sutton, chief currency strategist at Scotia Capital in Toronto, said near-term technicals are warning of the potential of further downside for the euro and suggest that a test down to $1.3425 is likely.

The dollar trimmed gains against the yen but remained at an 8-week high after data showed U.S. retail sales rose less than expected in January. For the retail sales report, click on [ID:nN15221247].

Higher Treasury yields have increased the appeal of the dollar versus the yen in recent weeks, with the greenback last up 0.6 percent to 83.79 yen JPY=.

"Loose monetary policy in Japan and a slow drift higher in the expectation for the Fed has put significant upward pressure on the U.S.-Japan 2-year spread," Sutton said, which in turn is pressuring dollar-yen higher. "We expect that USDJPY will continue to drift higher in the near-term and accordingly are in favor of short-term, long-USDJPY positions."

U.S. Treasury prices fell early on Tuesday and two-year note yields rose to their highest levels since May.
"Overall the euro is very vulnerable, and any rebound is likely to be unsustainable," said Ian Stannard, currency strategist at BNP Paribas. "There are concerns about the banking system, and yield differentials (between the euro zone and the U.S.) are heading lower, so all the ingredients are there for the euro to come under more pressure."
Peripheral euro-zone yield spreads have been widening in the past week on uncertainty over a rescue package for the region, and there was little sign the recent unease had been tempered by an agreement from European finance ministers on Monday.

Finance ministers agreed on Monday that a permanent rescue mechanism be set up from 2013 would total 500 billion euros, but there was no agreement over how to beef up its existing rescue fund. [ID:nLDE71D0JU]

The euro showed little reaction to German analyst and investor sentiment rising slightly in February amid confidence in Germany's economic recovery, according to a survey by the ZEW economic think tank on Tuesday. [ID:nLDE71E1HR]

Yield differentials were less favorable for the euro, with two-year German bonds yielding 0.54 percentage points more than U.S. Treasuries, the narrowest yield spread in nearly a month and sharply below a two-year high of 0.82 percentage points hit in January.

Scotia Capital's Sutton said while bond yield spreads between euro-zone periphery debt and Germany are still being pressured higher, 2-year spreads appear to be topping out.

"This will be positive for the euro," she said. "In the medium term we expect the euro to retrace recent losses and believe that by year-end the euro will have sustainably retraced all of its late 2010 losses."

Sterling rallied 0.7 percent after data showed for the thirteenth consecutive month the United Kingdom's inflation rate is above the upper target of the Bank of England. This fueled speculation that interest rates will rise in the near term as the Bank of England seeks to contain price pressures.

Wednesday's Bank of England's inflation report is expected to be hawkish and revise up near-term inflation projections, which could boost expectations that interest rates will rise soon and help the pound retain broad gains made this year.