LONDON (Dow Jones)--Selling the euro may become the preferred way for some traders to place bets or hedge risks on the region's rapidly deteriorating debt crisis, as it becomes increasingly tough to trade the currency bloc's bonds. The deepening crisis, and traders' desire to preserve profits as the end of the year approaches, is leading to a sharp drop in trading volumes of government bonds in the euro-zone periphery, market participants said Tuesday. Thin volumes are adding to sharp price swings and undermining policy efforts to repair brittle investor sentiment, with Spanish and Italian yield spreads rising to record highs again. "You cannot find a price to trade and there is hardly anything going through in the cash space," a London-based trader said. Deterred from trading bonds, some investors are gravitating towards selling the single currency instead, contributing to its increasingly rapid decline, market-watchers say. "When the bond markets become a guessing game and you can't really believe the spreads, people inevitably look to other instruments," said Hans Redeker, chief currencies analyst at French bank BNP Paribas in London. That approach won't work for all investors. A second trader in London said that the major holders of Spanish and Italian sovereign bonds are "real money" investors who take a longer-term outlook--such as pension funds, insurers and asset managers--and whose investments track bond indexes. These accounts can't simply switch from buying and selling bonds to trading currencies. Other investors, such as hedge funds, can be more flexible, and it's not unheard of for foreign exchange markets to act as a pressure valve in this way. When liquidity in one market segment dries up, "people look for [alternative] hedging instruments, and foreign-exchange is a good one," Redeker said. Details of Ireland's bailout released over the weekend have failed to allay fears of contagion, with Portugal and Spain seen as the next likely candidates for a rescue package. "You're definitely seeing liquidity being drained away in secondary markets in the euro-zone periphery on contagion fears," said Peter Goves, an interest rate strategist at Citigroup Global Markets. "The price action across the periphery has been rather pronounced," he said. "Peripheral liquidity is particularly poor now," said John Stopford, co-head of fixed income at London-based Investec Asset Management. "That's due to a combination of a reduction in year-end risk taking, and general nervousness around the periphery." Falling liquidity would also likely deter investors from buying sovereign bonds that they thought were undervalued, if they were worried that they would be unable to sell the bonds quickly if markets deteriorated even further. With bond market strains in the background, the euro fell hard in European trading hours Tuesday, dropping by a hefty 1.3% from the highest point of the day to hit a fresh two-month low of $1.2979 against the dollar. It also tumbled sharply against the Swiss franc, yen, and sterling. -By Neelabh Chaturvedi, Mark Brown, and Katie Martin, Dow Jones Newswires, + 44 (0)207 842 9495;

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