By Don Curren
Of DOW JONES NEWSWIRES
TORONTO (Dow Jones)--The durability of the euro's rebound from its recent four-year low is the key issue confronting currencies in the trading sessions ahead.
The euro has made a substantial recovery since bottoming out at $1.1876 on June 7, a roughly 16.5% drop since the beginning of the year. But the currency--now down about 13.6% so far in 2010--remains fragile, and is vulnerable to pressure from a number of sources, including new developments in the euro zone's sovereign-debt crisis.
Its rebound has been driven by some good news from the euro zone, including a successful Spanish bond auction and plans by the European Union to publish bank stress tests. The euro's recovery is attributable in large measure to investors booking profits on earlier negative bets against the common currency, so the recovery remains tenuous.
If the news in Europe continues to be positive, the euro could extend its two-week rebound in the short term, even though its longer-term outlook remains questionable.
Late Friday, the euro was at $1.2361, down from $1.2388. The dollar was at Y90.73, down from Y91.00, while the euro was at Y112.15, down from Y112.72. The U.K. pound was at $1.4801, down from $1.4820. The dollar was at CHF1.1097, down from CHF1.1119.
The ICE Dollar Index, which tracks the dollar against a trade-weighted basket of currencies, was at 85.705, up from 85.657.
Analysts see the euro trading in a range between $1.2200 and $1.2500 next week, with the potential for its recent correction to extend to $1.2700 in the weeks ahead.
"The recent euro rally is a corrective phase in a bear market and not a change in trend, but the upward momentum is strong and the $1.25 mark may be tested soon," said currency strategists at Brown Brothers Harriman in New York.
Since the common currency's rebound is partially a product of market players covering negative bets, it might not portend a sustained improvement, analysts say.
"Ultimately, when the market is this short a particular currency and a pullback happens, it results in some price volatility. It doesn't necessarily reverse the longer-term trend," said Jack Spitz, managing director for foreign exchange, financial markets and derivatives at National Bank Financial in Toronto.
The euro could slip into a pattern of sideways trading against the dollar after its recent volatility, said Shaun Osborne, chief currency strategist at TD Securities in Toronto.
The euro continues to trade heavily against other major currencies, notably the Swiss franc, and that could be an indication of a coming retreat against the greenback, he said.
The euro dropped to a record low of CHF1.3718 against the Swiss franc on Friday.
While the euro looks vulnerable, the yen appears likely to continue on its recent strengthening track. Analysts see the dollar moving between roughly Y90.00 and Y92.50, with a tendency to edge lower in that range.
"I think the yen may strengthen a little bit, although it will be in reaction to a more risk-averse environment, not for any fundamental reasons," Osborne said. "The yen is the mystery wrapped inside of the enigma, I think," he said.
The yen's strength this week in a generally risk-positive environment is somewhat puzzling, said National Bank's Spitz. "It's being seen in many respects as somewhat of a range trade," he said.
A move below Y90 by the dollar would likely invite "jawboning" by Japanese authorities in an effort to quell the yen's strength, Spitz said.
A handful of key events loom over currency markets next week.
One is the U.S. Federal Reserve's two-day open market committee meeting.
No one is expecting the U.S. central bank to raise interest rates, but investors will be scrutinizing its policy statement closely for any clues about future direction.
"At this stage, a significant change to its statement seems unlikely, with low rates for an 'extended period' retained," said currency analysts at ING in London.
"However, the chance of noteworthy alterations cannot be completely ruled out and this may prevent the [dollar] from softening as much as it might otherwise in the lead-up," they added.
Other notable events include the meetings of leaders from the Group of Eight major economies in Huntsville, Ontario, and the Group of 20 advanced and emerging economies in Toronto.
The G-20 event, which takes place next weekend, will be watched closely for any signals on currency policy.
Analysts say China's fixed-exchange-rate regime could be up for discussion during the G-20 meeting, although Chinese officials have said the meeting shouldn't be a forum for discussing the currency.
-By Don Curren, Dow Jones Newswires; 416-306-2020; don.curren@dowjones.com
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(END) Dow Jones Newswires
June 21, 2010 07:37 ET (11:37 GMT)
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