ITALIAN yields on benchmark 10-year bonds are once again above 7 per cent and Ireland may be the new sovereign debt hot spot in the Eurozone – Citibank economist and former BoE member William Butler suggests that the Emerald Isle is need of a second bailout. Yet, despite the turmoil, euro-dollar has rallied as the week progresses. The bullish price action must be extraordinarily frustrating to the shorts who are convinced that the single currency will fracture any day now, but there is actually a good explanation as to why the euro isn’t crumbling.

The latest Commitment of Traders report from the US Commodity Futures Trading Commission shows that euro shorts are at record highs, having increased to -139,000 contracts from -128,000 in the period prior. Simply put, the short euro trade is just too crowded and the pair needs to work off some of its grossly oversold conditions before it can resume its downtrend. Euro-dollar is also being helped by surprisingly strong economic data both in the Eurozone and the broader G20 universe that is dispelling fears of a possible recession in the region. No less an authority than IMF chief Christine Lagarde noted on Monday that the Eurozone may avoid contraction in 2012 as the core of Europe continues to perform well, despite the turmoil in the credit markets.

Meanwhile, the data from the US continues to improve and bolster equities, which in turn is supportive for the euro-dollar. Last Friday’s solid Non-Farm Payrolls report was only the latest in a line of positive surprises out of the US that suggests North America could be the driver of global growth this year.

This Thursday’s US Retail Sales and the ECB monthly press conference both due at 13:30 GMT will be the marquee event of the week that could determine the near-term direction of the euro. If Mario Draghi can convince the market that the ECB stands ready to provide ample liquidity, and if US Retail Sales beat forecasts, the one-two punch to euro bears could spur a strong short covering rally, pushing the pair towards the key $1.3000 level.