– EUR-crosses hold well despite negative Italian headlines
Markets are in negative territory this morning following news of Italian PM Monti’s resignation, with Italian equities off 3% and 10Y bonds off by some 30bps. However, the EUR has held up quite well with several EUR crosses holding above Friday’s lows (EURJPY an exception on JPY strength-more below). In a nutshell, our view on the news of Monti’s resignation are that while it increases uncertainty in the short-run, further out it has a silver lining as it could strengthen Monti’s position in Italian policy making. Clearly, by resigning it allows Monti to by pass any political fighting with Berlusconi’s party over key issues thus allows him to maintain his credibility. Still, euro zone risk premia could increase a notch in the days and weeks ahead. However, our point is that even accounting for this EUR positioning looks far too conservative heading into year end. The chart below compares the BNP Paribas measure of overall EUR positioning along with the inverse of our euro zone sovereign CDS measure. The take-away is that EUR positioning was reduced sharply following the increase in Spanish uncertainty from mid-September to end-October. Accordingly, the bar for a continued EUR rally is fairly low and the currency could continue to have an asymmetric response to news; rallying strongly on moderately positive news and declining modestly on negative news. Elsewhere, reports over the weekend suggest that Greece is very close to reaching the EUR 30bn of debt buyback mark. We expect a successful debt-buyback completion to result the Greek deal being finalised by Thursday’s euro zone finance ministers meeting. We maintain our year-end target of 1.3300 in EURUSD.
– Fed to reignite USD weakness, stay long AUDUSD
This week will likely be a pivotal one for the FX markets as we expect the Fed to roll the expiring Operation Twist into outright Treasury purchases on Wednesday. This would shift the amount of net balance sheet expansion of USD 85bn per month. The stronger than expected November US NFP report does little to change our Fed view. The headline gain of 146K jobs is probably still below the Fed’s threshold of a “substantial” improvement in the labor markets, which is likely to be around 200-250K. Furthermore, the Fed would need to see that stronger trend maintained for at least six months, implying that QE3 should stretch out well into the second half of 2013. On the US fiscal-cliff front, FX markets have recently been resilient to political posturing. We are likely to face another couple of weeks of uncertainty, but ultimately we believe that a deal will be reached before the end of the year. We thus maintain the bias for USD weakness into year-end. Our preferred way of positioning is through our long AUDUSD trade recommendation established at 1.0390 and targeting 1.0850. The end of the RBA’s easing cycle and generally stronger data from China (IP at 10.6% vs. 9.6% in Oct). We are likely to see more positive signals to maintain a proactive fiscal-monetary policy mix at the Central Chinese Economic Work Meeting which is likely to be held this week.
– USDJPY inability to rally on typically positive catalysts warns of correction
he upside momentum on USDJPY has clearly waned, with the cross unable to push higher despite the stronger US employment report, or today’s weak Japan GDP report. The market could focus on the more forward looking Tankan report (released Thursday) given the expectation for a sharp decline (-10 vs. -3 before on large manufacturer’s DI). However, we believe that the Fed meeting (Wednesday) will far outweigh any other event leading into the weekend elections in Japan. An announcement of outright US treasury purchases should see USDJPY decline sharply. While there is scope for the JPY to weaken on the crosses on expectation for the BoJ to turn increasingly dovish, we think there is significant scope for a post-election disappointment. Our strong suspicion is that even in an outright LDP win, the resultant government will not be representative of the uber-aggressive LDP head Abe. A switch to a slightly less dovish post-election political rhetoric could spark profit taking on extended JPY short positions.
BNP Paribas