FX: Why the Risk Rally is a No Brainer

  • FX: Why the Risk Rally is a No Brainer
  • EUR: Forces Combine to Drive EUR/USD Above 1.30
  • GBP: Employment Data on Tap
  • AUD: Unfazed by Weak Chinese Data
  • CAD: Sharp Improvement in Trade
  • NZD: Hits Fresh 8 Month Highs vs. USD
  • JPY: Risk Rally Drives Yen Lower


FX: Why the Risk Rally is a No Brainer

Currencies and equities performed extremely well today despite a wider U.S. trade gap and declines in small business and economic optimism.  We wouldn't be surprised if the weaker data even fueled the risk rally as investors are excited about the prospect of easier monetary policy from the Federal Reserve on Wednesday.  The improvement in the unemployment rate reduced the chance of overly aggressive moves by the Fed but today's deterioration in trade and sentiment will remind the central bank that its current level of stimulus needs to remain in place.  It is for this very reason that the Fed will announce a new program on Wednesday.  Operation Twist ends this year and with Congress yet to reach a deal on the Fiscal Cliff, there's no way the Fed will risk leaving monetary policy less stimulative going into the New Year.  While the Fed may like to extend Operation Twist, that's not an option because they are running out of short term bonds to sell.  The most likely choice is to buy $45B in Treasuries every month, bringing their total monthly purchases to $85B ($40B is currently spent per month on Mortgage Backed Securities). Without sales in the front end of the curve, the overall level of monetary policy will be easier.  The rally in risk is a no brainer because easier monetary policy supports the U.S. economy and by extension, global growth.  Therefore dollar lost value against every major currency except for the Yen.

The Federal Reserve's monetary policy announcement tomorrow is the most important event risk this week and it is that time of the year when we have an expanded version of the FOMC announcement. Here is the schedule:

  • 12:30pm ET FOMC Statement released
  • 2:00pm ET Updated Fed Forecasts
  • 2:15pm ET Bernanke Press Conference

The changes should show up first in the FOMC statement, which should lead to an immediate reaction in the FX market.  The Fed forecasts are not expected to change and therefore shouldn'y yield as much of a reaction.  However Bernanke's press conference is where everything can get interesting because he will be peppered with questions on the economy and future monetary policy.  If the Fed announces an open ended bond purchase program, it would provide further fuel to the risk rally but if Bernanke expresses skepticism about the improvements in the labor market, the risk rally could fizzle. For more on the FOMC meeting, please read our FOMC Preview.


EUR: Forces Combine to Drive EUR/USD Above 1.30

The 1.30 level continues to be an important point of contention for the EUR/USD.  The currency pair managed to rise above this level today but failed to soar above it in a convincing manner.  There are many different factors contributing to the strength of the euro including a sharp rise in the German ZEW survey, decline in Spanish / Italian bond yields and rise in European equities.  Part of the reason why investor sentiment in Germany turned positive in the month of December is because of the strong performance in German stocks.  This morning, the DAX reached a fresh 4 year high easing tensions and boosting optimism in Europe.  Economists were looking for an improvement but did not anticipate investors turning optimistic on the outlook for Germany's economy because the German government recently downgraded its growth forecasts.  Nonetheless, gains in equities can have a powerful impact on sentiment.  As for U.S. Fiscal Cliff talks, we haven't heard any new comments out of Washington but the WSJ argues that the "strict moratorium on public comments is considered sign of progress at bargaining table."  The hope for progress lifted risk currencies and financial markets around the world.  The euro also received support from EUR/CHF buying.  UBS became the second leading bank in Switzerland to impose a negative interest rate on other banks holding francs on deposit.  Interest rates are next to nothing making it extremely difficult for Swiss banks to cover the cost of business, let alone turn a profit.  The Swiss National Bank has a monetary policy meeting later this week and the question now is whether they will officially impose a negative interest rate.  We think its unlikely because in practice, short term government yields in Switzerland are already negative.   EU Finance Ministers are also meeting on Banking Supervision tomorrow.


GBP: Employment Data on Tap

The British pound ended the North American trading session slightly higher against the U.S. dollar and lower against the euro.  The only piece of U.K. data released over the last 24 hours was the RICS house price balance, which dropped from -7% to -9%. While this means the fall in house prices have accelerated, the index still remains well off its summer lows. The most important piece of event risk for the British pound will be Wednesday's employment report.  Jobless claims are expected to rise by 7.0k, down from 10.1k the previous month and the unemployment rate is expected to hold steady at 7.8%.  In other words, no major changes are expected in the labor market but based on the PMI reports, there could be a downside surprise.  The service sector enjoyed job growth last month but the manufacturing sector shed jobs at a faster pace and the construction sector employment dropped by the largest amount since December 2010.  If U.K. employment numbers surprise to the downside, the GBP/USD could give up some of its recent gains.


AUD: Unfazed by Weak Chinese Data

The Australian and New Zealand dollars powered higher against the greenback with NZD/USD rising to its highest level since February.  There were a number of reports out of New Zealand last night and most were in line with expectations.  House prices grew at a slower pace in November but credit card spending accelerating.  Business confidence in Australia fell sharply but that clearly had very little impact on the AUD/USD.  Instead, the strong rally in risk lifted all of the commodity currencies as the combination of lower risk and higher yield in Australia and New Zealand make the comm dollars particularly attractive.  We are bit surprised by the lack of gains in the CAD because Canadian data was unambiguously strong. The country's trade deficit narrowed to a mere C$169 million in October, down from C$1.01 billion in September.  Despite a sharp pullback in manufacturing activity, exports rose 1% while imports fell 1.2%.  This third straight month of improvement in trade should have fueled further gains in the Canadian dollar.  Further gains in the comm dollars will now hinge on the outcome of Wednesday's FOMC meeting and the market's reaction.  Australian consumer confidence is the only piece of economic data expected from the 3 commodity producing countries on Wednesday.


JPY: Risk Rally Drives Yen Lower

The Japanese Yen weakened against the major currencies. It was a quiet day in Japan as there was no economic data on the calendar.  Perhaps news that Japan is officially in recession is finally hitting the currency. The third largest economy has been heavily affected by the Euro-zone crisis, weak Chinese growth and the persistent rally of its currency and has yet to recover from last year's quake and tsunami. While some economists believe that Japan's economy bottomed in the third quarter, there is also speculation that next quarter's GDP will contract again due to sluggish exports to China. Deputy Governor Kiyohiko Nishimura said last week that the Bank of Japan may ease policy this month. The bank will closely monitor this week's tankan report for signs of deterioration in business sentiment.

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