– G10 currencies in tight ranges, EURUSD broke key support overnight
– Asian currencies weaker vs the USD, equities mixed
– FOMC kept policy unchanged
– Italy to auction 5-year papers, euro area IP likely flat
– Norges Bank to remain on hold with risk of 25bp cut
– We recommend selling 1yr in 1yr USDJPY FVA
What to watch for today
NOK: On hold but high risks of 25bp cut. Our economists think the Norges Bank’s rates decision today is likely to be a close call. Following the weak CPI print and the downbeat Regional Network survey last week, we think risks of a rate cut today have increased. While the real economy in Norway is yet to show significant deterioration, it is vulnerable to a loss in confidence, lower export demand, lower oil prices, and strains in the banking sector. Norway cannot insulate itself from what is happening in the euro area, its main trade partner.
Given the rates market pricing for a less than one-third chance of a 25bp cut, we think the NOK is likely to react negatively if the Norges delivers a cut. A dovish tone in the accompanying policy statement should be bearish for the NOK even in the absence of a rate cut. Our expectation for a bearish risk environment and recession in the euro area next year leaves us bearish on the NOK. We currently hold a long CADNOK position in our derivatives portfolio.
GBP: Poor labor data. Our economists expect labor data to deteriorate more than consensus in November. We expect a 10K increase in claimants count, with an 8.4% unemployment rate, above last month’s 8.3%. Disappointing activity data, combined with yesterday’s softer core CPI reading, is likely to support our bearish view on GBP against the USD.
EUR: Italy auction and USD tender. Italy will auction five-year paper today. The ECB will tender seven-day USD liquidity at OIS + 50bp, the second operation since the rate was lowered by 50bps. On the data front, our economists forecast a flat euro area industrial production in October, in line with the consensus forecast.
What happened overnight
The G10 currencies are trading in relatively tight ranges after sharp moves overnight. EURUSD traded through a critical support level at 1.3050/1.3045 overnight, the 61.8% retracement of the 2010/2011 uptrend to around 1.3030 currently. We note that the next support level is 1.2860, the low from the beginning of the year. AUDUSD is trading around parity, weighed by a sharp 8.3%mom fall in the Westpac consumer confidence index to 94.7 in December. This more than reverses the recovery in November and despite the 50bp RBA rate cut.
Asian currencies are mostly weaker vs the USD. The INR sell-off continues ahead of key inflation data today and Reserve Bank of India’s (RBI) policy meeting on Friday. USDINR traded to a high of 53.75 amid limited RBI resistance. In contrast, we understand that the Bank of Korea’s intervention helped push USDKRW down to1156. Asia equities are mixed, with the Nikkei down 0.6% and the Sensex up 0.4%.
USD: The Federal Open Market Committee (FOMC) kept policy unchanged. As expected, there was no mention of new communications strategies, discount rate cuts or of QE3. Rather, key sections of the FOMC policy statement were identical to the statement issued on 2 November. Our US economics team still believe that the Fed is preparing for a renewed round of large-scale asset purchases (QE3). Also, the FOMC seems poised to revamp its communications strategy in an attempt to provide still more transparency likely at the 24-25 January policy meeting. For more details, see: US Economics Digest: FOMC: A Quiet Close to an Unconventional Year, 14 December 2011).
IDR: Foreign holdings of Indonesian government bonds rose but outlook cautious. Foreign holdings increased to IDR223.9tn over the past two weeks from IDR214.8tn as of 30 November. However, our EM rates strategist thinks this reflects mainly the switching of maturing SBI proceeds to SPNs and should not be seen as a sign of renewed purchases. Monthly data also show that Bank Indonesia (BI) has been the main buyer of bonds, adding about IDR40tn of this year while banks have been marginal buyers, only IDR7tn YTD. We remain of the view that the 2012 supply calendar will likely trigger weakness in Indonesian government bonds as BI’s bond purchases are unlikely to be sustained and foreign buying muted. With the balance of payments now roughly balanced, we think this makes the IDR more vulnerable to capital flow weakness.
What to do
Sell 1yr in 1yr USDJPY FVA
Intervention fear as well as the low level of delivered volatility have pushed the front end of the USDJPY implied vol term structure significantly lower over the past couple of months. While front-end USDJPY vols have fallen to new multiyear lows, the long end of the curve has remained sticky. This has resulted in a sharp steepening of the USDJPY implied volatility curve. We recommend selling the 1yr in 1yr USDJPY vol on a forward basis via a Forward Volatility Agreement (FVA). The risk to the trade is potentially unlimited if implied vol at the end of the forward tenor is higher than the level at which the investor sells the FVA. For details see FX Strategist – Sell 1yr in 1yr USDJPY FVA
What to read today
Focus Asia (Q1 2012) – Better times? Our Asia economics team has turned more constructive on inflation and expect CPI inflation to fall sharply in most Asian countries in coming months. The team also expects growth to improve although it will be slower to come through. For equity markets and currencies in Asia, history suggests that a combination of lower inflation and stronger growth is almost always a potent, positive mix. Asian bond markets should also hold up well.
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http://www.easyforexnews.net/wp-content/uploads/2011/12/document-8047017501.pdf
Credit Suisse
FIXED INCOME RESEARCH & ANALYTICS