– EUR holds up to negative Italian news
FX markets are showing some notable resilience following news of Italian PM Mario Monti’s imminent resignation. Although Italian equities fell and Italy’s 10-year sovereign yields rose by some 30bp, the EUR’s dip below 1.2900 proved to be short-lived. Our view is that although Mario Monti’s resignation increases uncertainty in the short-run, there is a silver lining in that it strengthens Monti’s position and the range of available options ahead of the February elections. Meanwhile, Greece appears on track to complete its EUR 30 Bn debt buyback on Tuesday, which should open the path to the Eurogroup meeting finalizing the approval of the next aid tranche on Thursday. We also believe that 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. In the day ahead we will be watching Germany’s December ZEW economic sentiment which should improve to -12 –admittedly still a soft reading but an encouraging sign for ‘hard’ data in early 2013. We maintain our year-end target of 1.3300 in EURUSD.
– Risk propped up by Fed, stay long AUDUSD
The USD struggled to gain any traction at the start of the week despite the Italian jitters and the apparent lack of significant progress on the fiscal cliff after the meeting between President Barack Obama and House Speaker John Boehner. Clearly, markets are increasingly focusing on the Fed policy announcement on Wednesday. Although the view that the Fed will shift to outright Treasury purchases is now very widely shared by market participants, we do not believe it has been fully reflected into the FX price action. We continue to position for the FOMC via our long AUDUSD trade recommendation, established at 1.0390 and targeting 1.0850. The rationale is two-fold. First the AUD’s high beta to equities suggests the currency is likely to react strongly to the FOMC announcement. Second, we believe the markets have been overlooking the EM implications of aggressive Fed balance sheet expansion. Already apparent over the past several weeks, buying pressure on EM currencies should be supported by Fed action, leading to an increased FX interventionism by the EM central banks, notably in Asia. This ultimately implies USD sales against G10 currencies as those central banks maintain their current reserve allocations. Given the growing importance of AUD-denominated assets in the reserve managers’ portfolios, buying demand for the AUD is likely to persist in our view.
– USDJPY to run out of steam
The upside momentum on USDJPY has clearly waned, with the cross unable to push higher. 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 will far outweigh any other event leading into the weekend elections in Japan. 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. To underscore the point, however, even a somewhat more aggressive BoJ will struggle to match the pace of balance sheet expansion that the Fed should set at this week’s meeting. We maintain our mid-2013 forecast for USDJPY to fall to 76.00.
BNP Paribas