By Deborah Levine and William L. Watts, MarketWatch
NEW YORK (MarketWatch) — The U.S. dollar extended gains on Monday, with the euro coming under more pressure after a sale of five-year Italian government bonds came at the highest cost for the government since 1997.
Also, traders were worried that a new technocratic government in Rome still faces daunting challenges in insulating the euro-zone’s third-largest economy from the region’s debt crisis.
The euro EURUSD -1.30% fell to $1.3638, from $1.3745 in North American trade late Friday.
The dollar index DXY +0.71% , which tracks the U.S. unit against a basket of six major currencies, rose to 77.443 from 76.947.
The euro bounced back from a mid-week rout last week on hopes that a government led by economist and former European Commissioner Mario Monti would be able to implement austerity measures and economic reforms. The changes were demanded by Italy’s European partners and designed to reassure investors that the country can rein in its debt load. Read recent story on Italy’s Mario Monti.
Monti is working to assemble a government after Silvio Berlusconi formally resigned over the weekend.
“At this stage, even though the Italian political transition has proven to be orderly, and the likely new Monti-led technocratic government appears to enjoy broad-based support, ... investors are acknowledging that a change of government may not automatically translate into immediate improvements in Italy’s overall debt situation,” said Geoffrey Yu, currency strategist at UBS. “The resulting uncertainty still favors investors maintaining short positions in the euro.”
Still, demand rose at Italy’s auction of €3 billion of five-year government bonds. Bids exceeded supply 1.47 times versus 1.34 times in October. The auction produced a yield of 6.29%, a sharp rise in borrowing costs from a 5.32% yield in a sale of the same issue last month and the highest cost for Italy since before the euro’s inception.
The high cost is a sign that investors remain wary of not just “Monti’s ability to bring sweeping reform to the nation, but also a widening reach to the crisis,” said Andrew Wilkinson, chief economic strategist at Miller Tabak.
Yields across the Italian curve spiked above the 7% level at mid-week last week amid political turmoil and a hike in margin requirements before drifting back down to still-elevated levels.
Yields resumed a rise following the five-year auction, with the five-year yield IT:5YR_ITA +3.38% up 26 basis points to 6.61% and the 10-year yield IT:10YR_ITA -1.54% rising 34 basis points to 6.67%, according to FactSet Research. A basis point is one one-hundredth of a percentage point.
Looking at Spain again
Analysts also noted Spain’s yields, with 10-year note yields ES:10YR_ESP +0.24% topping 6% for the first time since early August.
Spain, Italy and France have debt sales this week, which traders will watch as a gauge of the country’s ability to fund themselves, according to Forex.com.
“In the scenario that demand comes in weak and yields surge, the euro is likely to suffer as the correlations have risen significantly over the past few weeks,” they wrote in emailed comments.
The dollar tends to rise on safe-haven flows as risk aversion increases, while falling when investors show more risk appetite.
“While the U.S. economic data has improved, the Greek and Italian political developments have reduced a lot of the tail risk in the euro and suggest short positioning may consequently be reduced,” wrote strategists at Lloyds Bank in London.
The British pound GBPUSD -1.17% traded at $1.5929, down from $1.6058 on Friday.
Against the Japanese yen, the dollar slipped to 77.02 yen USDJPY -0.33% from ÂĄ77.17.
Deborah Levine is a MarketWatch reporter, based in New York.
William L. Watts is a reporter for MarketWatch in Frankfurt.
