* Euro recovers from 1-month low but outlook remains bleak * Euro zone rescue fund may not reach 1 trillion euros * Fund managers see safety in dollar, yen, Norway crown By Julie Haviv NEW YORK, Nov 11 (Reuters) - The euro rose for a second straight day against the dollar on Friday as Italy's approval of austerity measures boosted risk appetite but did little to lift optimism about the single currency. The euro held onto gains after Italy's Senate approved a new budget law on Friday, clearing the way for approval of the package in the lower house on Saturday and the formation of an emergency government to replace one led by Prime Minister Silvio Berlusconi. Euro selling pressure eased on signs of political stability in Italy and Greece, with former European Commissioner Mario Monti the favorite to replace Berlusconi. In Greece, prime minister-designate, Lucas Papademos, will name a crisis cabinet to roll out austerity plans. In early New York trade, the euro was up 0.6 percent at $1.3684, far above Thursday's one-month low of $1.3484, with traders citing demand from Middle East accounts. But gains were limited by offers above $1.3700. "The market is so short the euro that just the mere absence of bad news for a day or two can cause it to rise, so this is just a pause," said Greg Anderson, G10 strategist at CitiFX, a division of Citigroup, in New York. "A lot of things have to go right over the next couple of weeks for the euro to continue to gain, namely the smooth passage of Italy's austerity measures into law and a transition of power to a semi-stable government that shows someone responsible is at the helm." Political turmoil in Italy and Greece is complicating efforts to increase the firepower of the euro zone's bailout vehicle to 1 trillion euros, an official at the European Financial Stability Facility said on Friday. "There appears to be little demand for the EFSF bonds, and the investors primarily targeted have not been buying them," Anderson said. "That is also negative for the euro." U.S. bond markets were closed in observance of the U.S. Veterans Day holiday. The U.S. stock market remained open.A euro's break below Thursday's low could leave the it targeting the early October low of $1.3145. Before that, support lies around $1.3405, the 76.4 percent retracement of the euro's $1.3145 to $1.4248 rally. UNDERWEIGHT EUROS Stephane Monier, head of fixed income and currencies at Lombard Odier in Geneva said that in recent weeks he had further cut positions in the euro and Swiss franc in favor of other currencies. "In terms of what we consider safe-haven currencies in the short run, apart from the dollar, which could also benefit from political risk in the Middle East, we are positive on the Norwegian crown, the yen, and maybe sterling," Monier said. He said had become overweight in those currencies in the past six weeks, after becoming increasingly short on the euro since summer, and going underweight Swiss francs after the Swiss National Bank has successfully limited the franc's rise. His firm has $36 billion in assets under management, $16 billion of which are invested in fixed income assets. Market positioning in options suggests investors are bracing for a further slide in the euro, with euro/dollar one-month risk reversals trading at extreme levels around 4 in favor of euro puts -- bets on euro falls. Some traders said hedge funds have bought euro puts with strikes around $1.26 that are due to expire in six weeks. The dollar fell 0.6 percent against the yen to 77.18 yen , the lowest since Japan's massive yen-selling intervention on Oct. 31. Market sources have told Reuters that Japan has probably intervened in the foreign exchange market since then.

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