EURO ANALYSIS

Year-end flows and thin market liquidity on Friday caused USDJPY to slip below 77.00. This took EURJPY under 100.00 for the first time in over a decade. German Chancellor Merkel said she would “do everything to strengthen the euro” but that “a single currency can only then be really successful if we work more closely together in Europe.”
The latest IMM positioning data shows that EURO short positions hit another record high last week. The IMF published its quarterly survey on the composition of central bank FX reserves. The USD share rose to 61.7% at end of Q3, up from 60.3% previously. Also, the share of reserves held outside the G5 traditional reserve currencies fell slightly for the first time in two and a half years. These so-called ‘other’ currencies now account for only 4.8% of reserves, down from 4.9% previously. We note that valuation effects were responsible for the apparent shift in reserve holdings due to a bout of USD strength towards the end of September.
Governor Noyer of the French central bank said that the EURO may be ‘the world’s number one currency’ in ten years. In a surprise announcement, the recently installed Spanish government revealed that Spain’s 2011 deficit is likely to come in at close to 8% of GDP, much higher than the 6% target originally forecast. A program of austerity measures and tax hikes worth EUR 8.9 bn were announced to get things back on track. Greek Prime Minister Papademos said the government “must continue our efforts with decisiveness, to stay in the EURO”. Greek Central Bank Governor Provopoulos warned against a return to the drachma, noting “Living standards would plunge. The new currency would be significantly devalued, possibly by up to 60-70 percent”. Separately the latest opinion poll showed that 77% of Greeks wish to keep the EURO.
On Friday, EURUSD traded 1.2904-1.2999 and USDJPY 76.89-77.74. The 2yr yield spread between German and US sovereign paper stands at 9 bp at the time of writing, and remains in the USD favour.