Risk Sentiment May Improve, But Not For Euro. By Nicholas Hastings

There is risk and then there is euro risk.

And we are watching the first turn into the second this week.

Classic risk has dominated the market for some time as fears over a double dip recession in the U.S. have continued to hover and investors have preferred safe haven currencies, such as the dollar and the yen, at the cost of high-yielders, including the euro.

However, risk sentiment looked set to improve.

Not only did last Friday's U.S. employment data show signs of improvement but both the White House and the U.S. Federal Reserve finally appear ready to take the bull by the horns.

President Barack Obama has proposed $50 billion of infrastructure spending that will provide another fiscal injection for the country's spluttering recovery.

Also after weeks of hinting at it, Fed officials now look ready to provide another tranche of quantitative easing, the so-called QE2. In a speech on Tuesday, the Fed's former vice chairman Donald Kohn suggested that this is only a matter of time and analysts are now speculating that the move will come at the Fed's policy meeting in early November.

So far so good, safe havens should have lost their attraction and high-yielders, including the euro, should have been back in favor.

But, we have had a shift to euro-specific risk instead.

See how the euro will come back under pressure against the dollar:



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Concern over the U.S. recovery has been replaced with concern over the euro zone recovery as well as the continued risk of sovereign debt default.

A sharp reminder of the economic difficulties facing the euro zone came over the last week as industrial activity and export orders, particularly in Germany, slowed sharply. This illustrated just how quickly the country's export driven recovery earlier this year will come to a shuddering halt, removing the one bright spot on the euro zone's economic landscape.

This immediately put the spotlight back on European banks, which appear to have underestimated their exposure to sovereign debt in stress tests conducted earlier this year.

Deteriorating growth prospects among the euro-zone's peripheral debtors have also raised the risks of a debt default as these countries struggle to meet their repayment obligations.

Over the last 24 hours, the cost of insuring against default in many of these countries has risen back to their recent highs or even beyond, as in the case of Ireland.

All this has driven home to investors that the euro zone's bank and debt problems are far from over and that they will likely rumble on for some time to come.

It isn't surprising that the euro has found itself being driven down to a new all-time low against the Swiss franc and that hopes for some recovery in the euro back over $1.30 have quickly disappeared.

Instead currency players are waiting to see how long it will take the single currency to break down through $1.26 and bring an end to recent suggestions that the euro could still stage a more prolonged rally.

Early Thursday, the euro was once again under pressure, falling to $1.2683 by 0645 GMT from $1.2716 late Wednesday in New York, according to EBS. Although market sentiment had earlier been lifted by a Beige Book suggesting that the U.S. economy is still expanding even if at a slow momentum and a hawkish rate hike by the Bank of Canada.

Stronger than expected employment data from Australia and a rally in Asian stocks all contributed to the improved mood.

However, as European trading got underway the focus returned to the risk associated with the euro zone's peripheral debtors as the market waits to see how much Ireland will have to pay at its auction of EUR400-600 million of six-month and eight-month bills later in the day. Yields over 2% to 2.35% could be seen as a sign that investor support is waning.

The euro was also down at Y106.22 from Y106.72 while the dollar fell to Y83.72 from Y83.92 as the market continued to speculate that the Japanese will hold off on intervention until after next week's leadership election in the ruling DJP party. The new leader would automatically become prime minister.

In the meantime, Bank of Japan Governor Masaaki Shirakawa reduced expectations of an imminent move by reporting that intervention wasn't discussed in a meeting with the government.