Any Greek debt restructuring plan would open the door to euro selling toward $1.30 U.S., by hitting European banks and private investors and raising questions about the euro zone's overall creditworthiness.
Such jitters have already dogged the euro, which slumped to a two-month low of $1.3968 on Monday, retreating from a 17-month high near $1.50 U.S. touched earlier in the month.
The latest euro losses have coincided with soaring costs to insure Greek debt against default as investors survey the prospects for a restructuring including a possible haircut.
Some analysts say the euro has ample room to fall, adding that a drastic Greek restructuring, or signs that Spain may be set to join the club of indebted euro zone nations seeking aid would push the single currency to $1.30 U.S. or even lower.
At the same time, the euro could see some support around $1.40 U.S. if a shift in market focus to fiscal and economic weakness in the United States triggers selling in the dollar.
Following are scenarios of possible outcomes and risks for the Greek debt crisis, and their impact on the euro.
The FX market's main scenario is for a "soft restructuring" of Greek debt soon, in which bondholders would be expected to keep their exposure to Greece by agreeing to maturity extensions, rolling over debt at maturity, or other measures.
Ratings agency Fitch last week said it would consider any extension of existing Greek debt maturities a default.
But fund managers say a plan which limits contagion risks to Ireland and Portugal, which are also struggling with debts, plus optimism that Europe has the political will to solve its debt problems, will ultimately offer a reason to buy the euro.
Currency market participants see little chance of an immediate haircut on Greek debts -- which would require debt holders to take an across-the-board loss on their exposure -- but many do not rule out such a prospect in the future.
This contrasts with the bond market, which is pricing in the possibility of Greek debt haircuts that could wipe 50-70% off the current value of sovereign debt.
This scenario could prompt a big selloff in the euro, according to some experts.
Such concerns have already hit the credit default swaps market, with benchmark five-year Greek CDS jumping to a record high above 1,400 basis points on Tuesday.
Similarly, the euro would also take a big hit if investors see a heightened risk that Spain may also require assistance to repay its debts, as it would confirm that the euro zone debt crisis continues to spread to other countries.
The possibility of contagion was highlighted by Moody's comments on Tuesday that a Greek default could trigger credit rating cuts for Portugal and Ireland, and by Standard & Poor's weekend downgrade of Italy's sovereign rating outlook.
Analysts said they saw only a very low risk of Spain turning to the European Union and International Monetary Fund for help. They added that a fall in the euro to its 2010 low below $1.19 U.S. was unlikely provided any fallout from action on Greek debt is limited to Ireland and Portugal.
Some in the market expect that, barring a drastic Greek restructuring, the euro will maintain its relative strength versus the dollar, which is suffering from its own problems.
A weak U.S. economy, low interest rates, and a growing focus on the need for Washington to tackle its own massive borrowing offer a range of reasons to sell the dollar versus the euro.
At the same time, analysts argue all is not doom and gloom for the euro, thanks to ongoing signs of strength in core countries including Germany, and the prospect of higher interest rates which would reinforce the euro's rate advantage.
Not only could this shield the euro from excessive losses, relative strength in the German economy versus the United States would see a pick up in the euro, returning it to around $1.50 U.S.
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