Euro springs back

The euro drifted higher against the dollar on Tuesday after three days of losses as risk aversion eased somewhat on gains in stocks and commodities while investors cashed in bearish bets on the single currency ahead of Sunday's Greek election. The euro's gains were capped by record high Spanish bond yields, reports of official preparations for a Greek exit from the euro zone and uncertainty about the logistics of Spain's bank bailout.
Rising scepticism over a 100 billion euro ($124.57 billion)bailout for Spain's banks pushed Spanish government bond yields to their highest since the euro was launched in 1999. Spanish yields subsequently retreated from their highs late in the session.
Investors are concerned over how difficult it may be for Madrid to access debt markets in the longer term. Current holders of Spanish debt are worried about falling to the back of the line for repayment. "There's a bit of relief that things in Europe are somewhat moving in the right direction and we get the sense that Germany is more willing to help," said Charles St-Arnaud, currency strategist at Nomura Securities in New York.
The euro last traded at $1.2503, up 0.2 percent on the day, but above a session low of $1.2441. BNP Paribas' exchange rate indicator suggested that at this level, the euro was fairly valued versus the dollar. Against the yen the euro rose 0.3 percent to 99.40 yen.
Concerns that the Greek election on June 17 would bring to power parties opposed to its current bailout plan and force a disorderly exit from the euro zone were rekindled by a report that EU officials were considering ways to manage the fallout. On the other hand, a victory for the pro-bailout group could provide some relief and cause the euro to bounce.
As a worst-case scenario should Athens decide to leave the euro, European officials have discussed limiting the size of withdrawals from ATM machines, imposing border checks and introducing euro zone capital controls. Robert Sinche, global currency strategist at RBS Securities in Stamford, Connecticut, said there is a small chance, however, that after the Greek election and under strong G-20 pressure, Germany could indicate a willingness to ease on fiscal restraint in the euro zone at the group's meeting in Mexico next week.
The options market reflected the skittishness among traders with 1-week euro/dollar implied volatility spiking to a six-month high at 15.4 percent as quoted by ICAP, up from 10.5 percent last Friday. The cost of protecting against a euro zone decline also increased on Tuesday, with three-month euro/dollar risk reversals rising to a high of 3.275 percent from 2.850 percent last week. The yen fell after the International Monetary Fund said it was moderately over-valued and there was a chance of further yen appreciation due to Europe's debt crisis. The dollar was slightly higher against the yen at 79.50 yen.