Position Squaring Featured Ahead of Key Events, Data Shrugged Off

The euro has been the biggest beneficiary of the bout of position squaring ahead of tomorrow's ECB meeting. The move began yesterday and has survived the three-notch downgrade of Italy's sovereign rating by Moody's and a new erosion in the service sector PMI (to 48.8 from the 49.1 flash reading and 51.5 in Aug)and poor Aug retials sales (-0.3% on the month, -1.0% year-over-year).

Ideas that Greece may have sufficient funds to last through mid-Nov and reports that European countries are discussing a synchronized bank recapitalization plan may be being seized upon as a reason to square up extended short euro positions.

Key resistance is now seen in the $1.3385-$1.3400 area. A move above there would likely signal a new wave of position adjusting and turn sights toward $1.35.

Two European countries appear to have bucked the disappointing service ISM. The first is Ireland. It unexpectedly rose to 51.4 from 51.1. Ireland still looks the best of the periphery in Europe and the Irsih 5-year CDS is near 4 month lows. The UK is the other surprsing exception. The CIPS services rose to 52.9 from 51.1 and contrasts with expectations for a decline to 50.5. This would seem to tilt the odds even further away from a resumption of asset purchases at tomorrow BOE meeting.

Evne though sterling is still lower against the dollar near midday in London, it appears to have put into place a potential double bottom just below $.15350. Problem is the neckline whose pentration would confirm the pattern is not found until $.15700.

Separately, the Nikkei Shimbun reports that Japan is interested in EFSF bonds, which should not be surprising. It bought about 2.7 bln euros of EFSF bonds in H1. There are several ways it can buy those EFSF bonds, which are triple-A and offer a higher yield than bunds. First, it can sell other euro denominated instruments. Second, it can sell dollars and buy EFSF bonds, which would be a way to diversify reserves. Third, and what appears most likely is that Japan would sell yen to buy EFSF bonds. It has increased its financing bills capacity which funds the intervention. It would also generate some reserve diversification, though it would increase its overall reserves, which itself may be a bit of a trap.

Japan's Bank for International Cooperation (JBIC) is making a $43 bln line of credit available for Japanese large banks for foreign M&A. This is part of the program to help Japanese corporations cope with yen strength. It comes just as the Europeans seem to be moving toward a new bank recapitalization plan. Can these two developments be related if not in intention, in practice?

Korea reported reserves fell $8.8 bln in Sept, the largest monthly decline in nearly 3 years. Korea is the eighth largest holders of reserves that had hit a new high of about $312 bln. Although officials there seemed to cited valuation adjustment, talk in the market has been that the BoK has been intervening.

Recall the note in this space last week noting that the Fed's custody holdings fell $35 bln in the most recent week and about $50 bln in the month of Sept. Of course, we do not know if Korea uses the Fed's custodial services, but the point is that intervention to slow the local currencies decline, or smooth it out, may see the region's reserve holdings generally slip. That said, valuation adjustment likely also played a role, with those central banks the more aggressive in diversifying reserves paying a greater price.