The euro reached 2-1/2-month lows against the US dollar on Tuesday and posted its worst month since May, with more losses likely next month as fears about eurozone debt run rampant and prompt risk aversion. The euro extended losses after Standard & Poor's said it was placing its A-minus long-term and A-2 short-term ratings on Portugal on CreditWatch with negative implications.
The euro was last down 1 percent against the dollar at $1.2983, not far from a session low of $1.2969 touched on trading platform EBS earlier, its lowest since September 15. Camilla Sutton, chief currency strategist at Scotia Capital in Toronto, said downside pressure on the euro remains well in place after going below the $1.30 level.
"All the pieces are in place that we should see some stability in bond markets and the euro, but we will undoubtedly see further weakness in the near-term," she said. "The sovereign debt issue has morphed into a confidence crises." Nevertheless, the euro will likely end 2010 around where is currently and reach $1.40 by the end of 2011, she said.
The euro was down nearly 7 percent on the month, on track for its worst monthly performance since May when Greece received a bailout. In tandem with euro weakness, the premiums investors demand to hold Spanish and Italian sovereign bonds over German debt jumped to lifetime highs while yield spreads on Portuguese, Irish and Belgian bonds also widened.
Analysts said given the sharply negative sentiment on eurozone assets, the European Central Bank should take a more active hand in managing the crisis. As a result, talk of an ECB quantitative easing would not be surprising, said Boris Schlossberg, director of FX research at GFT in New York. The ECB's meeting this Thursday is crucial as investors will be looking for comments on how the bank could help address growing anxiety in the credit and currency markets. It is also expected to keep rates on hold and sources say it could extend banks' access to unlimited three-month funds beyond January.
A financial rescue deal for Ireland failed to contain contagion fears and drove the euro below the critical $1.30 level, with traders saying the next key figure was $1.2794, the 61.8 percent retracement of the June to November rally. Some traders cited minor support at $1.2920, the September 6 high. That level preceded a steep rally in the euro that took it all the way to that early November high at $1.4283. On the upside, resistance is at $1.3040.
Other eurozone-linked assets such as euro exchange-traded funds also fared poorly. The CurrencyShares Euro Trust traded on the Chicago Board Options Exchange was down 0.86 percent at $129.60 after hitting a 2-1/2-month low at $129.23. This ETF holds euro on-demand deposits in euro-denominated bank accounts. Euro/dollar implied volatilities spiked on Tuesday to a peak of 15.55 percent, the highest since at least June, suggesting nervousness about the eurozone currency.
The one-month 25-delta risk reversals, a gauge of currency sentiment, traded as low as -2.85 vols for euro puts versus a close of -2.73 on Monday. Further reflecting the euro's negative bias, the latest positioning data from the Commodity Futures Trading Commission showed speculators going net short on the euro for the first time since September 14. The dollar continued to gain against a currency basket, hitting a more than two-month high at 81.444 with help from safe-haven flows and recent evidence of an improving US economy.