The euro has held up relatively well on the foreign exchanges despite a two-year-old sovereign debt crisis that has seen euro-denominated bond yields rising to record levels and talk the currency bloc may not even survive.

The euro has weakened in recent weeks as euro zone debt yields have soared with a solution to the crisis elusive, though investors have held off from selling the currency aggressively compared with other assets.

While the single currency has retreated from $1.42 to hit a one-month low of $1.3421 this week, it is up nearly 2 percent so far this year, and its recent pull-back has lagged declines in bonds issued by weaker euro zone countries and in European shares.

Below is a list of questions and answers on why the euro has avoided a bigger sell-off.


The deepening euro zone sovereign debt crisis has yet to trigger an exodus from the shared currency as portfolio flows from debt issued by highly indebted states have gone into German Bunds, resulting in no foreign exchange outflow.

Some analysts also argue the euro's fall has been relatively subdued due to speculation the Federal Reserve may embark on more quantitative easing before the end of the year. That would probably weaken the dollar across the board.

Fed President Ben Bernanke has raised the prospect of buying more assets from the market to boost the U.S. economy.

A lot of people still don't believe the U.S. is not going perform more quantitative easing by the end of the year, said Adam Myers, currency strategist at Credit Agricole CIB.

At the moment, that's far more important than what's going on in the euro zone, from the currency perspective.


The latest IMM data shows speculators continue to bet on more euro weakness. These bets, called short positions, hover around their highest since mid-2010, when investors were first fretting about the possibility of a Greek default.

As the outlook for the euro zone debt crisis has darkened since August investors have shifted into bets for euro weakness, reversing positions favouring a rise earlier this year.

As these bets to sell have piled up, some investors have been trimming back on concerns that too many people are taking on similar positions.

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.

Asset managers have been selling for the 14 of the past 15 weeks. That tells you how short people are, said Geoffrey Yu, currency strategist at UBS, quoting the bank's flows figures.

That's why the euro is not weaker ... Right now it's difficult to push it lower given heavy downside positioning.


UBS client flows show that while asset managers and corporates sold the euro versus the Swiss franc and sterling last week, hedge funds picked up the single currency.

Custodial flows from Bank of New York Mellon indicate demand from big institutional investors including pension funds, have been buying the euro since late October.

Others in the market say European banks, facing tighter lending standards from their global counterparts, have also been buying the single currency as they cut their net foreign asset position to reduce balance sheet risk.

If you have to cut your balance sheet, the most likely asset you will cut is the asset which has not been funded in the same currency as where the asset had been held, said Hans Redeker, head of currency strategy at Morgan Stanley.

A 2.5 percent rise in the euro versus eastern European currencies, including the Czech crown and the Polish zloty since late October is one result of this, analysts say.


The options market suggests investors are actively protecting themselves against further volatility and weakness in the euro even though it has been resilient on the spot market.

One-month euro/dollar risk reversals, which measure the balance of demand between puts and calls -- options to sell or buy a currency -- hover near 4.0 vols in favour of euro puts, after soaring to a record high of 4.2 last week.

This shows a high premium on the right to sell the euro over one month, while the tilt in favour of puts over three months or longer have been at all-time highs for weeks.

This has resulted in a tightening positive correlation between one-month risk reversals and widening yield spreads between Italian and German bonds, suggesting a further expansion in spreads may boost the premium on euro puts even more.


Analysts believe crunch time for the euro would come if investors pulled out of German debt, which would be a sign of a real possibility of the euro zone breaking up or of a separation between the bloc's stronger and weaker countries.

This would result in a massive euro sell-off as investors fled the safest euro zone assets for the alternative liquidity of U.S. Treasuries and gold.

There's a growing feeling that having your money in Germany is not a guaranteed safety, said Myers at Credit Agricole.

At the moment, 10-year U.S. Treasury yields are slightly higher than Germany's, but analysts say an inversion in their spread prompted by rising German yields and falling U.S. ones would be a sign of safe-haven flows into the United States.

Myers expects Treasuries to outperform Bunds in the coming weeks, adding this could knock the euro below $1.30 before the end of March.