Euro slips on Italian political risk, US bond yield rise

The euro hovered near five-month lows on Thursday as investors fretted about the demands of Italian populist parties and as a fresh rise in US government bond yields underpinned demand for the dollar.

The euro laboured close to the $1.18 mark at $1.1795 and down 0.1 per cent on the day, slightly above the $1.1763 2018 low it hit on Wednesday.

The euro has slumped from more than $1.24 in April after a blistering dollar rally in which investors have bet that US interest rates will need to rise further to curb inflation while other central banks postpone tightening.

That has forced investors with big positions against the dollar, which had been predicted to fall in 2018, to rush to unwind and cover their positions, pushing the greenback even higher.

Some analysts say the market is still complacent about the possibility of the dollar rising.

“This sense of a market that is not particularly well prepared for a euro decline is supported by the benign valuations still evident in the pricing of six-month and 12-month implied volatility,” said BNY Mellon in a note, referring to the six and 12 month price of a gauge of expected volatility in the euro.

The dollar index against a basket of six major currencies dipped 0.2 per cent to 93.180 but was in close reach of 93.632, its highest since December 19 marked on Wednesday.

US Treasury yields continued their recent rally with the 10-year government bond yield hitting 3.12 per cent, the highest since 2011.

The euro is also suffering after reports Italy's anti-establishment 5-Star Movement and the anti-immigrant League may ask the European Central Bank to forgive 250 billion euros of debt as the parties worked to draft a coalition programme.

“The euro looks on track for further losses as market participants still appear to have more long positions on the euro to liquidate,” said Yukio Ishizuki, senior currency strategist at Daiwa Securities in Tokyo, while predicting that the fallout from Italy could we well contained.

Elsewhere sterling gained briefly after a media report that Britain would tell Brussels it was prepared to stay in the European Union customs union from 2021 onwards. The UK dismissed the report.

The dollar rose 0.2 per cent 110.575 yen, its highest since January. The Australian dollar added 0.2 per cent to $0.7529 after gaining 0.6 per cent overnight, buoyed by a rise in prices of commodities such as copper. Other commodity-linked currencies like the Canadian dollar also advanced.

Volatile emerging market currencies did not fare as well. Rising Treasury yields have enhanced the dollar's appeal and raised global borrowing costs.

Emerging markets with current account deficits face the risk of fund outflows and their currencies declining further, analysts say.

Brazil's real dropped to a two-year low against the dollar overnight while the Indonesian rupiah retreated to its weakest since October 2015 on Wednesday.

The Turkish lira and Argentina's peso have been at the heart of the storm. Both traded down again but below record lows hit earlier in the week.

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