Euro firm after round of short-covering; downtrend intact

The euro held firm on Tuesday after a choppy session overnight saw a wave of short-covering lift it by more than two cents on hopes that China will bolster Italy by buying its bonds, but traders found few reasons to stay upbeat about the currency.

The euro was last down 0.1 percent at $1.3670 , having jumped off an overnight low around $1.3495 after the Financial Times reported that Italy had asked China to make "significant" purchases of Italian debt.

The downside trend, however, stayed intact as markets come to grips with the prospect of a Greek debt default after senior German politicians started talking openly about it and a European Central Bank official quit amid policy disputes.

"All eyes are squarely on that seven-month low around $1.35 hit overnight," said Koji Fukaya, director of global foreign exchange research at Credit Suisse Securities in Tokyo.

"The downtrend in the euro will surely continue, but my sense is that unless the Italian bond auction goes extremely badly, this level may hold today," he said.

Italy is offering up to 7 billion euros of new long-term paper later in the day, with the auction in focus after the previous long-term sale drew tepid demand and as the spread of Italian bond yields over German Bunds rose to about 380 basis points, close to a peak near 400 basis points hit in August.

Markets are also bracing for a possible ratings downgrade on France's top banks, as well as an Italian sovereign rating cut. Moody's warned on June 17 that it may cut Italy's credit ratings in the next 90 days.

Chart-wise, the euro looks heavy, after a short-covering rally stalled ahead of the top on the weekly Ichimoku cloud at $1.3705 and the 100-week moving average at $1.3739.

"Having failed to bounce back above $1.37, the euro has become extremely vulnerable on the charts. I wouldn't get my hopes up for the auction -- the euro is still a sell," said a trader for a Japanese bank who spoke on condition of anonymity.

But the trader also said that as the euro is oversold in the short term, it may find some immediate support. Other traders added that the potential euro slump will likely be bumpy and peppered with short-covering rallies like the one seen on Monday.

The common currency has already fallen about nine cents, or 6 percent, in two weeks from a high around $1.4548 hit on Aug. 29.

It is now trading on the verge of the lower Bollinger Band, now at $1.3646, and its 14-day relative strength index is hovering around the 30 mark, which is considered to be oversold territory, for the first time in more than nine months.

EURO/YEN UNDER PRESSURE

Against the yen, the euro fell 0.2 percent to 105.31 yen , but was off a 10-year trough plumbed on Monday at 103.90 yen.

Traders said that the sharp fall through 105.00 and 104.00 in euro/yen overnight has knocked out some Japanese exporter hedges, and that heading into the fiscal half-year end at the end of September they may have to re-sell the common currency.

Risk reversals also showed increasing demand for bets on a lower euro, with the 25 delta one-month euro/yen risk reversal rising to levels not seen in over a year, trading around 4.4 in favour of euro puts. more