Six Observations about the FX Market

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1. Of the three central banks that meet next week, Australia, UK and euro zone, the first two are expected to ease monetary policy (rate cut and new asset purchases respectively) but those two currencies have easily outperformed the euro over the past week, suggesting monetary policy expectations is not the only driver, or even a significant driver.

2. The market had appeared to be gearing up for a test on the resolve of the BOJ and SNB to cap their respective currencies, but now appears to be backing off.

3. The euro has been range bound this week between $1.3025 and $1.3235. This is within last week's range. However, in the options market the premium (3-month) puts has risen relative to calls. This suggests that a) those who bought euro calls to protect short positions are taking profits and b) with the euro's upside momentum faltering, new put buyers are re-entering the market. These signals from the options market warns of downside risks to the euro.

4. Yen calls trade at a premium to yen puts ostensibly because Japanese corporates repatriating overseas earnings (including export earnings). Yet for the first time since at least 2003 (when Bloomberg data begins) yen puts are at a premium to yen calls (against the dollar). Some times the insurance function of options is the driver. Some time the operative function is parallel to spot. Our work with this suggests that the options market is warning of further dollar gains against the yen.

5. The correlation (60-day percent change) of the euro and S&P 500 has trended lower since peaking in early December near 0.86. It is falling below 0.70 today to its lowest level since early October. The 30-day correlation has broken down even more. It is falling below 0.47 today for the first time since June. The risk-on/risk-off matrix is continuing to fragment.

6. Emerging markets in general seem to be in a win-win situation. They rally when investors think the risks of QE3 are high and they have strengthened more recently, including today, on stronger real sector data.