Jousting in the FX Market

There are several important developments today.  In terms of price action, the yen is the most noteworthy.   It has sold off as the market anticipates next month’s election will produce an LDP-led government that is talking very aggressively about breaking deflation’s grip and arresting yen strength, through open-ended QE, interest rates at or below zero and an elevated inflation target (3% has been bandied about rather than 1% current goal).

The dollar moved above JPY81 for the first time in seven months.   Implied volatility (3-month) has jumped today from about 7.5% to almost 8.5%, the highest since July amid talk of demand for JPY82-JPY83 dollar calls.

 

The Australian dollar has the dubious honor of being the second weakest currency today behind the yen.   It is off about a cent from yesterday’s highs to near a 2-week low.  It has fallen out of favor amid talk of a bond redemption and S&P warning that the country’s AAA rating may be at risk if the government fails to deliver a fiscal surplus in 2014.  

There is also some concern that the Reserve Bank is trying to curb the strength of its currency.  Data out earlier today showed that the RBA sold a net AUD483 mln in October, the most since June 2009.  This follows sales of around AUD400 mln in August and September, which is something on the magnitude of more than four times the average seen over the last couple of years.  It appears that the RBA is directly meeting the demand for Australian dollars for reserve purposes by other central banks.   With intra-day technical stretched as the Aussie nears its 200-day moving average (~$1.0323), it may be difficult to sustain the downside momentum here and now.  However, a break could spur another cent decline in the coming days. 

   

On the other hand, sterling, which is largely flat, is more resilient than one might have expected given the shocking miss on retail sales.  October retail sales in the UK collapsed 0.8%.  The consensus was for a flat report.  Adding insult to injury the 0.6% rise in September was revised to 0.5%.  This is the biggest decline in April and the weakness was broad based.  

Yesterday the Bank of England cut next year’s growth forecast in half to 1% and Moody’s warned that it may downgrade the UK is the economy enters a renewed contraction.  Since Q4 is largely backed in the cake at this juncture, Q1 13 is key.  The Chancellor’s Autumn Statement on December 5 will be anxiously awaited for clues into the how the government will navigate between austerity and growth.  

Sterling did record a new two-month low against the dollar in the immediate response to the retail sales, but recovered quickly.  The $1.5800 area roughly corresponds to the halfway point of sterling’s nearly 10 cent rally from June 1 through Sept 21. 

The euro area reported Q3 GDP figures.  The region posted its second consecutive quarterly decline.  The 0.1% contraction follows a 0.2% contraction in Q2.  The preliminary data warns the area is contracting this quarter as well.  

The highlights include Italy, where the 0.2% contraction was half of what the market expected, and France that saw a 0.2% expansion instead of the stagnation that was expected.  However, Q2 was revised to -0.1% from flat.  The third quarter was the first quarter since Q# 11 that France was able to report an expanding economy.  Germany and Spain’s figures (+0.2% and -0.3% respectively), were in line with the preliminary data.  

The big negative surprise was the Netherlands.  Its economy contracted 1.1% on the quarter.  The market had been prepared for a 0.2% contraction.  Q2 growth was shaved to 0.1% from 0.2%.  The GDP shocker may have some fiscal implications for the new government. 

There are two developments in ongoing euro zone debt crisis to note.  First, a German paper is reporting that euro area finance ministers are considering approving only 13.5 bln euros of new funding for Greece (through lower interest rates on existing borrowings) which is supposed to cover Greece through 2014.  They may leave it go for another day (summit) how to secure the other 17.6 bln euros it is projected to need in 2015-2016.  Perhaps by then Greece will be running a primary budget surplus and will be in a different negotiating position regarding an official sector haircut.

Second, a report suggests the Spain’s Rajoy is considering going directly to the IMF to seek funds rather than the ECB and Europe’s facilities.  This is likely to be a non-starter, but it does show Rajoy recognizes his country does in fact need more assistance and that the government is still grappling with a limited range of choices.  Note  that risk that the ECB’s OMT is not triggered may be a factor weighing on the short-end of Spain’s curve, while the long end is firm.