The eurozone periphery's deeply ingrained debt problems, the social impact of austerity measures and a possible rebound in the dollar could see the euro re-test and break through four-year lows above $1.18 by mid-2011.
Intervention by the Bank of Japan to push up the dollar from a 15-year low against the yen and expectations of further easing by the US Federal Reserve have pushed the single currency to a one-month high against the dollar and a five-week high versus the yen, but these gains could be fleeting. Fundamental problems within the eurozone periphery are likely to dent the single currency as austerity measures potentially lead to upheaval and undermines investor confidence.
Recent disappointing German data, such as a sharp fall in the forward-looking ZEW economic sentiment survey and weak manufacturing numbers, suggest the eurozone's fledgling recovery, which has largely been driven by Germany, may be at risk.
The euro hit a four-year low of $1.1876 on June 7, having endured a prolonged period of selling that started towards the end of 2009. It is still down more than 8.5 percent against the dollar this year and has lost nearly 16 percent against the yen.
In the options market, risk-reversals show a premium being charged to hold euro puts, suggesting the market is still hedging against another move to the downside in spot, particularly over a longer timeframe.
The one-month 25-delta has reflected a recent rise in the euro but still shows a negative bias, around 0.80 in favour of euro puts. Further out into 2011.
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