Tuesday Surprises

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The US dollar remains confined to recent trading ranges against the major currencies as the European session gets under way.  The Asian session already had two surprises for the market.  The first, that the Reserve Bank of Australia defied expectations and left rates on hold was a genuine surprise and produced a market reaction.  The Australian dollar was bid through the the $1.08 level for the first time since early last August.

The second surprise was the confirmation by the Bank of Japan that following the record one day intervention on October 31, it did in fact intervene during the following days in a stealth mode.  To be fair, there had been some market talk that this was occurring at the time and there was a rise in balances at the Bank of Japan.  What is noteworthy about the intervention is the size.  

The BOJ had previously confirmed that its unilateral intervention on October 31 involved selling some JPY8.07 trillion (roughly $100 bln).  Today it confirmed that in the November 1-4 period it sold another JPY1.02 trillion yen, apparently trying to defend some of the modest deprecation it had achieved.  That intervention however was well above the amount it used during the March 18th coordinated operation (~JPY692.5 bln).  

Given the objections of the US Treasury and European officials to the unilateral BOJ intervention some suggest that the bar to BOJ intervention is high.  Changing tactics to more stealth intervention is a possibility, but as today's report illustrates, the details do emerge.  It does not stay stealth for very long.  

We have argued that the relatively low volatility, speaks to the fact that the market is not presently disorderly. We also have pointed out that the for the first time since at least October 2003 (when Bloomberg data begins), the market is paying a premium for yen puts over yen calls (the standard 3-month tenor 25-delta). This speaks to the fact that market positioning may not be as skewed as has been the case in other interventions. 

Moreover the yen's strength does reflect fundamental considerations.  The overriding consideration is not the fact that Japan is running a trade deficit, but rather than with short-term interest rates converging, Japanese investors are somewhat more reluctant to recycle their capital account surplus (investment income plus foreign purchase of Japanese securities).  In addition the uncertain surrounding the European crisis may also discourage strong capital outflows from Japan.  

It may require the yen to rise to new record highs against the dollar for the Ministry of Finance to order the BOJ to intervene in the foreign exchange market.  

The Greece saga continues to play out.  The private sector involvement (PSI) was a prolonged negotiation, but it appears largely resolved.  The problem now, reports indicate, is in the demands from the IMF-EU for more Greek savings.  However, the real problem appears within Greece.  The political leaders cannot agree among themselves.  

And for good reason, an election is around the corner (most likely now in April) and the austerity being demand risks a significant backlash--a general strike by the largest public and private unions today.  

Former  Socialist Prime Minister and still head of the largest part in Greece, Papandreou wants to push out elections, but Samaras, the head of the second largest party and likely next prime minister, is opposed and wants elections as soon as possible, ostensibly after an agreement is reached.  

There was meeting yesterday that barely drew attention, but may be very telling.  The triple-A countries in the euro zone met yesterday in Berlin.  Represented were Germany, Netherlands, Finland and Luxembourg. France, who is regarded as the second pillar of Europe (along side Germany) was not represented.  It is true that S&P cut France's rating last month, but at the worst, it is a split rating as according to the other major agencies, France is still an AAA credit.  

Over the course of the financial crisis, the veneer has been torn away and it is clearer that France is not Germany's equal.  The gap between the two grows even if the premium France pays over Germany has narrowed from the 150 bp on 10-year yields seen in recent months.  However, at 100 bp where the spread is today is still wide relative to any but the most recent period.  Over the past decade the spread has averaged about 20 bp.  

Ahead of Thursday's Bank of England and European Central Bank meeting, the US dollar is likely to chop within recent ranges.  The passing of deadlines in Athens has not seen the euro break support in the $1.3000-20 area.  At the same time, rallies above $1.3200 have not proven sustainable either.  Sterling resistance is seen in the $1.5880-$1.5900 area.  The dollar has been confined to about a 25 tick range against the yen.  Initial resistance is seen near JPY76.90 and a break of it could see a quick move toward JPY77.40.