The euro slipped Monday as investors sought growing yield premiums to hold Italian and Spanish bonds versus benchmark German debt, reflecting worries that wrangling between European leaders will protract the bloc's debt crisis.
The shared currency slipped to the day's low of $1.3445 in early European trade. An overwhelming Spanish vote in favor of a new government failed to instill optimism about Madrid's ability to deal with its economic problems.
But even as the euro zone's debt financing problems grow, analysts expect the dollar to suffer too this week if a U.S. congressional super committee fails to agree on a $1.2 trillion deficit reduction plan.
Many have been surprised by the euro's resilience to the surge in Italian and Spanish bonds yields which make it ever more costly for their governments to manage their debt.
The euro has a lot of support at $1.35, and it's been difficult to push it lower despite the problems in the euro zone, said Arne Lohmann Rasmussen, chief analyst at Danske in Copenhagen.
From a speculative point of view, the market is already very short on euro/dollar, he added.
The latest IMM data show that speculators ramped up their bets to sell the euro last week, making it less profitable to put on new positions to sell.
In addition, a market full of one-way bets may trigger a sharp jump in the euro if investors seek to lock in profits on the currency's losses.
The euro traded nearly half a percent lower on the day as the yield spread between Spanish and German 10-year government bonds yawed 10 basis points to 453 basis points, while the Italian/German spread also expanded.
But some in the market expect the euro may to rise to around $1.36 this week if Washington formally announces failure of its deficit-cutting effort, which is expected to happen later in the day.
Rasmussen at Danske said that such a level would be a good opportunity to sell the euro.
Losses in the shared currency on Monday pushed the dollar .DXY up 0.3 percent versus a currency basket.
But it slipped 0.2 percent to 76.66 yen as speculation about the U.S. deficit committee shook confidence in the world's largest economy, prompting investors into the yen, which is perceived to be a safer haven despite Japan's own huge debt burden.
Many analysts believe the European Central Bank's unwillingness to commit to large-scale bond purchases and Europe's deteriorating economic backdrop mean global financial markets will remain hostage to stresses in Europe, which could sting the euro.
In this environment, we continue to favor being defensive in currency markets, analysts at Barclays Capital said in a note, suggesting being long the dollar versus European currencies.
Being short EUR/USD has been frustrating for several reasons, notably the repatriation of European bank exposures abroad ... we therefore prefer to be long the USD versus cyclical European currencies that are directly exposed to the euro area such as the SEK (Swedish crown).
The European Commission will propose on Wednesday much tighter control of euro zone countries' budgets and closer economic monitoring which, if proven to work, could lead in a few years to some form of joint euro bonds, a senior euro zone official said.
While such a move could help bolster confidence in the longer term, few think such drastic measures could be taken any time soon, given Germany's staunch opposition to the idea.
(Additional reporting by Tokyo Forex Team; Editing by Ruth Pitchford)