D-Day for Europe? And What's Up with the Yen?

The euro has remained firm even as the US S&P tumbled yesterday, Asia stocks slip and expectations for the outcome for today's summit continue to ratchet lower. It does continue to stall out in the $1.3950-60 area. The $1.3840-50 area still marks the first level of support, though the $1.3890 area held in both Asia and Europe.

At most, an agreement in principle and some broad understandings are the most that should be expected from the summit. Further development is likely ahead of the G20 summit on Nov 3. The general shape--what seems most likely--at this juncture is EFSF as insurer for new Italian and Spanish issuance, around 100 bln euro bank recapitalization by the middle of next year, before turning to that national government and then the EFSF.

There may be a special purpose vehicle set up that will invite outside investors. The IMF may offer precautionary lines of credit to Italy and Spain. A new and deeper "voluntary" haircuts toward 50% or more on Greek exposure will be sought. There is talk that the IMF seeks an even larger cut. The ECB's independence will be preserved. It will not be forced to be involved with the EFSF schemes.

Yet, there seems to be something else going on euro. There is widespread talk that European banks are selling off dollar assets and repatriating the funds. This reduces their dollar funding needs and reduces their balance sheet. It makes some sense, but there doesn't seem to be much evidence for it either. It may be better thought of a hypothesis in search for support. Separately there is talk of Middle East euro demand as well. On the other hand, Russian names were thought to have offers that have capped the advance.

Still, sterling is faring well too and straddling the $1.60 area. UK CBI Trends report (industrial) was much weaker than expected at -18 from -9 and expectations for a -7 reading. The details are even worse. Sterling held the $1.5980 area.

Leaving Europe, Australia reported a softer CPI report and this increases the likelihood that the Reserve Bank of Australia cuts rates next week. Note too that iron ore prices have dropped sharply in recently. The Australian dollar is the weakest of the majors, dropping almost 1% before stabilizing. Resistance now is seen near $1.04. New Zealand reported soft inflation too but the central bank is going to remain on hold. The Bank of Canada's monetary report is unlikely to elicit the same dramatic response as the dovish statement that followed yesterday's policy meeting. The Canadian and New Zealand dollars are likely to outperform the Australian dollar in the coming period.

The BOJ meets tomorrow. There is talk that it may increase its asset purchase program by 5 trillion yen (a 10% increase). It is also possible that is performs its own operation twist and buys longer dated Japanese government bonds.

One thing it won't do is decide to intervene. It is not it's call, but the MOF's. The dollar has slipped to new record lows, but gradually and marginally and despite elevated verbal intervention, nothing material. The Japanese government, it seems, are turning to fiscal policy to address the yen rather than monetary policy. By fiscal policy I mean government assistance and guarantees to help businesses cope with yen's strength.

The options market is also detecting anything that looks disorderly. 3-month implied volatility is modest at 10.7%, below the 50 day ave of 10.9%, to put it in perspective and well below the 14.3% euro vol. The premium for yen calls over yen puts has been increasing in recent days and this may be the way some participants have placed their bets. Take advantage of relatively low volatility to buy yen calls, which may give one more staying power than spot.