Hedge funds increased their bets against the euro to a record level in the last week of 2011, increasing pressure on the embattled European common currency as it enters the most testing year of its history.
Many hedge funds lost money betting against the euro for much of last year, as the currency remained unexpectedly strong despite the continent's worsening financial crisis.
However, the euro suffered a poor November and December and ended the year as the worst performing major currency, dropping to a 10-year low against the yen and a one-year low against the U.S. dollar.
This triggered a renewed surge in bets against the currency in the week ending Dec. 27, according to data from the Commodity Futures Trading Commission in the U.S., released late in the U.S. on Friday.
The number of short positions in the euro – where investors benefit from a decline in prices – outweighed long positions by a record 127,900 contracts by Dec. 27, up from 113,700 contracts the previous week. The value of the contracts is not disclosed.
"When we see extreme short positions like this it normally means a short-term correction for the euro," said Carole Laulhere, a strategist at Société Générale. "In the longer term the economic fundamentals are more important, but those are also weakening."
The euro fell 0.2 per cent to €1.29 against the U.S. dollar on Monday, despite a report that showed modest improvement in euro-zone manufacturing data, supporting European stock markets. The currency shed 3.6 per cent against the dollar last month.
The CFTC data only capture a small part of positions in the euro market - one of the largest and most liquid in the world.
The euro-dollar exchange accounts for more than a third of the world's daily foreign currency trading, according to the Bank of England.
Yet the data illustrate a good part of the activity of U.S.-based hedge funds and are considered a proxy for the investment industry's views.
The euro's resilience for much of 2011 baffled many analysts, and to the chagrin of funds that bet against the currency.
Some attributed it to several factors: inflows into "safe haven" German bonds; currency diversification by emerging market central banks away from the dollar; and capital repatriation by European banks retrenching from operations outside the region.
Analysts expect the euro to come under more sustained pressure in the first half of the year.
The single currency will fall to €1.28 against the dollar by the second quarter of 2012, according to a median of 41 analysts surveyed by Bloomberg.
However, analysts still differ markedly on the euro's direction, highlighting the dangers of shorting the currency.
While Nomura expects the euro to fall to €1.20 against the dollar by the second half of the year, and Standard Chartered predicts €1.22, JPMorgan's analysts predict the euro will recover to €1.34 and BNP Paribas' to €1.35