FX Shakeout

The reversal in the holiday period positioning that began yesterday in Europe has gained momentum, producing a shakeout of long euro and sterling positions and short US dollar and yen positions.  The dollar-bloc, which lagged during the holiday period, are little changed today.  This also supports the sense of that market positioning, perhaps after the long-awaited resolution to the fiscal cliff was provided in half measure (revenues first spending latter, maybe).  

The euro shed two cents since yesterday's high to trade at three-week lows.  Sterling, which saw 17-month highs yesterday near $1.6380, has also dropped a couple of cents.  It is not just against the dollar, but the yen as well, where the shake out is evident.  The euro, for example, was testing the JPY116 level yesterday and is near JPY114 now.  

The immediate question is what North American participants do given the dramatic price action since in Europe.  We suspect they will fade it.  That means they are likely to see the pullback in the euro, and maybe to a lesser extent sterling, as a new buying opportunity.  The bounce in the yen will also likely be seen as a new opportunity to get with what is thought to be the medium term down trend. 

It is not that there aren't fundamental developments, it is tough to align them with the news, other than "buy the rumor, sell the fact" type of activity.  Investors know almost instantly that the Senate bill that the House approved postponed for two months important spending cut decision.  It also knew that the contentious so-called Bush tax cuts became permanent for the vast majority of Americans.  It also knew that the payrolls savings tax holiday was over.  

The response by the rating agencies was not surprising.  S&P and Moody's noted that the measures do put the US fiscal trajectory on a sustainable medium term path.  S&P said the agreement will not change its rating, while Moody's was waiting for the outcome of subsequent decisions on spending.  Both have the US on negative credit watch for well over a year.  Meanwhile, the early forecasts show economists estimate the fiscal to be between 0.75% and 1.5% of GDP.   The recession that the CBO warned that was likely on a full cliff dive appears to have been averted.  

Economic news has not been supportive of the euro's recent rise.  The euro was still near $1.33 yesterday when it reported the disappointing manufacturing PMI.  The main economic news from the euro area today was the 3.8% year-over-year rise in November M3 money supply and a smaller than expected (3k vs 10k) rise in German unemployment.  The pace of money supply growth was just less than the 3-year high set in October.  However, the increase in money supply is not reflected in new loans.  New loans to the private sector fell 0.8% after a 0.5% decline in Oct. 

Sterling began coming off yesterday after its unexpectedly strong manufacturing PMI, and today was sold further on a disappointing construction PMI (48.7 vs 49.3 in Nov and expectations for 49.5).  Residential building was especially weak.  Construction, though is a small part of the UK economy and the service sector PMI is due out tomorrow.  The consensus calls for a small increase to 50.5 from 50.2.  Separately the BOE noted that biggest rise in the availability for credit for mortgages and corporations in at least five years, as the Funding for Lending Scheme gets traction.  The demand side seems tepid still.