Forces at Work: Euro, Yen, Swiss franc

This is the first substantial upside correction in the euro in the better part of two months. The euro’s move above its 20-day moving average puts momentum traders on alert. While the next target comes in near $1.2300, given the extended positioning and the pace of the losses in recent weeks, a short-covering fueled recovery can exceed technical objectives.

There was talk at the end of last week of some leverage fund interest in short-dated euro calls, with 1-month $1.25 strikes seemingly popular. The recent news stream has encouraged the short-covering. The ECB promised to provide unlimited liquidity over the next three months and this has helped ease some strains in the money markets. At the end of last week, Moody’s offered a fairly optimistic assessment of European banks’ ability to cope with losses related to their holdings of peripheral euro zone bonds. China and India’s recent string of data gave hope that the global recovery was intact despite the volatility of the capital markets. The ECB revised its forecast for euro zone growth to 1.0% (from 0.8%) and the Bundesbank revised up German growth to 1.9% this year from 1.6%. Earlier today the CBI lifted its forecast for UK GDP this year to 1.3% from 1.0%.

Last month there had been concern that the key pillar of Europe, the Paris-Bonn axis was strained, but Sarkozy and Merkel showed greater signs of cooperation/coordination with the co-authored letter to the EU last week urging the expedited action on financial reform. Earlier today the euro zone reported better than expected April industrial production figures.

The 0.8% rise in April industrial output compares with consensus expectations for a 0.5% increase and the March series was revised to show a 1.6% increase rather than 1.3%. This news stream has also seen the 3-month implied volatility of the euro ease below 14% (from above 16% a week ago) and is now at its lowest level since mid-May. The premium the market pays for three-month euro puts euro calls has fallen from almost 3.5% a week ago to about 2.3% today, the lowest since early May.

Japan is participating in the better news steam as well. Today it reported sentiment among its large manufacturers improved markedly, with a 10 reading on its index compared with 4.3 last quarter. Of particular note, they said they plan to boost capital expenditures by 9.7% in the current fiscal year. Last quarter they projected a 5.5% cut in capex. This report may help lift expectations for the next Tankan survey due out 1 July.

The BOJ’s two-day meeting concludes tomorrow. Of course, no change in rates is expected, but the market does anticipate more details about the new loan program. Local press reports suggest the facility may be capped at JPY2 trillion and will be aimed at lending for targeted purposes (environment, energy, medicine and technology. The dollar briefly poked through the JPY92 level, but the generally heavy US dollar tone seemed to discourage new buying above JPY92.10. To keep the tone constructive for the dollar, it needs to hold above JPY91.50.

The Swiss National Bank also meets this week—17 June. There is little doubt that it will keep its 3-month LIBOR target at 0.25%. Earlier today Switzerland reported a 0.3% rise in May producer prices. The year-over-year pace stood at 1.4% from 0.8% in April and expectations for an increase to 1.2%. There is some thought that the SNB may revise up its growth and inflation outlooks but without altering its declared QE/intervention stance.

The dollar has broken below the CHF1.14 level for the first time May 18th. The dollar’s 5-day moving average has crossed below the 20-day average for the first time since April 21st, further illustrating the dollar’s loss of upside momentum. A break of the CHF1.1330 area could see another 1-2 big figure decline. On the euro-franc cross the CHF1.40 level is a key overhead barrier.