Consolidation in FX

A consolidative tone has emerged after yesterday's powerful reversals after the warm reception to the initiation of the ECB's 3-year funding facility. Although the argument advanced in this space is that banks will 1) use the funds as a liquidity cushion, 2) service own liabilities, and 3) to the limited extent they increase sovereign bond holdings, they largely stick to their own sovereign's.

Of course, the early January auctions, like the January 13 Italian and the January 29 Spanish bond offerings will be extra closely scrutinized. Overnight deposits at the ECB are elevated and will likely rise further. Stress in the financial system remains powerful as numerous measures show, like the 3-month currency swap rate and the Euribor-OIS spread.

As the markets enter the holiday mode, what is striking is that the short-term speculative market is still very long dollars. Typically in these kind of markets, new positions are not established for the most part, but old positions come off. The old positions are long dollars.

Do not understand this to mean a change in the underlying view. Variously macro-economic and financial variables I look at point to a weaker euro, for anything but the shortest of terms.

Three developments catch my eye today. First, although the UK reported a slight upward revision to Q3 GDP (0.6% vs 0.5%), the real news was the current account deficit blow out--GBP15.2 bln as investment income collapsed. Adding insult to injury the Q2 shortfall was revised from GBP2 bln deficit to GBP7.4 bln.

Second, Japan's government cut its GDP forecast for the current fiscal year to -0.1% from +0.5%. Next year's GDP forecast was cut to 2.2% from 2.7-2.9%. This is still above market expectations, where the median is below 2%. Some suspect that the higher GDP forecast will be used by some to push for the long-threatened retail sales tax increase.

Staying in Japan, the weekly MOF portfolio flows showed foreign investors bought a whopping JPY2.6 trillion of Japanese bills in the most recent week. Some will link this to safe haven flows, but suspect it is also more complicated in terms of offsetting swaps or other funding operations. This also underscores the argument presented here previously that the answer to the riddle of yen strength is the inability of the Japanese to recycle not the trade surplus as was the case previously, but the capital account.

Finally, Swiss government talked tough about how strong the franc is still, but when push came to shove parliament voted against measures that would have led to negative interest rates. In terms of the franc, the key is the SNB not the government.