Three Impulses Dominate FX at the Week's End

As the week draws to a close, there are three independent drivers in the foreign exchange market.  The first two are the weakness in the yen and sterling.  The third is the push higher in the euro.  

We had not expected the dollar to close above JPY90 in North America yesterday and it has not looked back.  Comments from some Japanese officials, suggesting a dollar move to JPY100 would be acceptable.  Prime Minister Abe apparently dissatisfied with the BOJ moves this week again threatens to revise the BOJ's charter, though his appointments in March-April could rectify the situation.

Arguably just as important as the jawboning is the data.  In the last 48 hours Japan has reported a larger trade deficit, an extension of the streak in which exports are falling and news that consumer prices that show the extension of deflation.  The headline CPI fell 0.1% year-over-year and while this appears better than the 0.2% decline in Nov, core reading deteriorated.  Excluding fresh food (-0.2% from -0.1%) and excluding food and energy (-0.6% vs -0.5%) show movement in the wrong direction.  In addition, Tokyo CPI, which is for Jan instead of Dec was -0.6% year-over-year on the headline.   The bottom line is that much more aggressive easing of monetary policy will be necessary if the 2% inflation goal will be credible. 

Sterling has traded poorly all week, following last week's convincing break of the trend line going back to last June  It also finished last week below the 200-day moving average for the first time in five months.  It has not looked back either.  The fundamental catalyst today is the weaker than expected Q4 GDP.  It contracted by 0.3%.  The market was expected a milder 0.1% decline, though there were some last minute rumors of a stronger report.  The economic weakness was concentrated the industrial sector (-1.8%), but services stagnated, offering no offset.  Sterling extended this week's losses and fell to its lowest level since August. 

Although the idea of the UK leaving the EU has been debated following the PM's referendum call (2017) earlier this week, the real problem is more immediate.  The government wants to stick to its austerity strategy and the BOE shows a reluctance to provide more monetary stimulus.  The IMF has suggested the government ease up on its austerity drive, but this was rejected.  Diluting its agenda, and the UK government faces a credit downgrade and potential political backlash.  However,  a deeper recession can threaten the very same thing.  

Sterling has also been crushed against the euro for the fourth consecutive week.  The euro has moved above GBP0.8500 for the first time since late 2011.  Against the dollar, the euro has finally busted through the $1.34 level that has capped it in recent weeks.  The next target is near $1.35.  Cross rate pressure, stronger German IFO report, and larger than expected repayment of LTRO funds.  

The ECB reported 278 banks will repay 137.2 bln euros that were borrowed under the LTRO facility.  A news wire polls had produced a consensus of about 85 bln euro repayment.  Recall that in the first LTRO from late 201l,  which is now subject to repayment, some 489 bln euros were borrowed.  The greater than expected repayment saw short-term euro rates move higher on ideas of less liquidity.  The euro traded to new highs for the day ostensibly on higher yields and larger reduction of the ECB's balance sheet. 

The stronger German IFO follows the better than expected ZEW survey and the gains in the PMI (especially in the service sector).  At 104.2, the IFO climate reading stands at a 7-month high.  The IFO economists think the results points to a 0.2% expansion in Q1 13, while the Markit economists say their PMI is consistent with 0.3% growth.  

Lastly, we note that the dollar-bloc currencies continue to be sidelined.  The antipodean currencies are little change, sitting in relatively narrowed ranges near multi-week lows.  Meanwhile, the US dollar is holdings above CAD1.0 for the first time in 2-months.  A move above CAD1.0050 could spur another cent advance in the coming weeks.