* USD weaker but EUR continues to underperform
Despite a lacklustre equity market display on Monday, USD weakened across the board. Asian markets have sustained the momentum, sending local and commodity currencies higher, helped along the way by another large Chinese trade surplus and little sign of waning appetite for commodities. The EUR remains an underperformer, and there is increasing talk that the single currency is set to become the global funding currency of choice. Such a development would suggest that the current record positioning is less of an obstacle to further EUR weakness. Back in the mid-2000’s when the JPY was the funding currency of choice, ever-larger short positions did not interfere with the continuing weakening of the JPY. But the current EUR circumstances are not yet comparable with those that facilitated the yen carry trade: despite recent declines in the front-end, implied volatility remains relatively high; while the yield differentials available to investors in any significant size are limited. Also arguing against a more significant shift into a EUR-short carry-trade is the patent lack of EUR lending as record amounts are deposited overnight at the ECB. In the short term we continue to see EUR prospects as bleak not only on the potential headline risk but also pressured by large EGB issuance this week. EUR crosses should remain under pressure, especially against relatively liquid AAA sovereigns. EURGBP is likely to continue to move lower barring any retracements on oversold conditions.
Click here to read the full report: Daily FX Str_Europe_10 Jan 2012