Euro Nerves Still Raw. By Katie Martin

The euro has gained of late, but it has looked rather like a tired man running up an escalator that's heading down.

Since the troubled single European currency sank to a four-year low against the dollar earlier this month, it has rallied by over 3.5%.

Many analysts are baffled; after all, it's not as if the situation in the euro area has improved. If anything, as nerves continue to build over Spanish debt, and as major euro-zone powers continue to bicker on the best way forward for bank stress-tests, the situation is getting worse.

Nonetheless, it looks like the bears have grown weary. The euro-bashing frenzy has paused, and some traders have closed their bets, shoving the currency higher.

"Some of the most extreme bets appear to have been squared," said the analysts at Commerzbank in Frankfurt. The move may take the euro as high as $1.25, judging from chart patterns, they said.

All the same, "it remains a position-led correction. From a fundamental point of view, the arguments against the euro seem to be increasing," the bank said.

Certainly, the new-found relative stability in the euro appears brittle. There's an uneasy sense that it would take just one grim headline, one new shock, to tip the currency back into free fall.

And the coming weeks are loaded with a huge number of potential triggers for that move. In particular, as JP Morgan pointed out in a recent note to clients, over the next six weeks, European sovereigns and banks will be raising new debt to pay back existing bondholders at an abnormally heavy rate.

These borrowers are set to roll over some EUR215 billion of bonds in June, and EUR275 billion in July. The monthly average is under EUR160 billion.

Of the sovereign debt, only around one-third comes from the euro area's wobblier states. For the financial debt, it's around one-fifth. Still, new debt issues mean new risks. "Coming at a time when core markets are also generating such high supply, there are decent odds that some auctions and placements do not run smoothly," said John Normand, a senior analyst at JP Morgan.

A grim run of failed or lackluster issues would almost certainly deal a heavy blow to investors' confidence--a risk to the region's bond markets as a whole.

"Dramatic (bond spread) widening runs the risk of turning this bond market repricing into a systemic issue as it did in May," Normand said. That would shove the euro lower against the dollar, just as in May, Normand said, but it would likely propel it higher against higher-risk currencies like the Australian dollar, which would be vulnerable to a broad pullback in risky bets.

So the risk of currency-market shocks stemming from the bond markets is very substantial, and that's before one considers the ghastly risk that Spain or one of the other fiscally stressed euro-area states could spook the markets without warning.

Few see this euro rally against the dollar continuing much longer. It's just a question of when it stops, and how far the correction runs.

In early European trading Thursday, the euro was lower at $1.2266 against the dollar, from $1.2311 late in New York Wednesday, according to trading system EBS.

The dollar was steady against the yen, at Y91.28 from Y91.42, while the euro was weaker at Y111.97 from Y112.56. Sterling was weaker at $1.4669 from $1.4737.