USD and JPY on the back foot

Running into the end of the year it is clear that the USD is turning into the biggest loser. In part this reflects year end flows but also the dovish Fed stance and uncertainty about a resolution of the fiscal cliff. Indeed, with the Fed FOMC meeting out of the way the lack of progress on averting the fiscal cliff is quite disconcerting. Market confidence of an agreement appears to be slipping judging by the weakness in risk assets at the end of the week.

The USD is unlikely to make up much ground in the days ahead despite some likely positive data releases including yet more data showing housing market recovery, gradually improving manufacturing confidence gauges as well as a revision higher to Q3 GDP.

The EUR is on the verge of ending the year in strong form (too strong for Eurozone economies) as news of agreements on Greece’s loan tranche and banking supervision have given the currency even more support. Much of the rally in the EUR is likely to come from position adjustment into year end and could reverse quickly into new year, however.

Nonetheless, there is no doubt that receding tail risk due in large part due to continued support from expected eventual ECB asset purchases (OMT) activation will limit any downside in the EUR. In the near term the EUR may still take some direction from the German IFO survey on Wednesday but assuming that this survey continues its stabilisation, EUR/USD will likely maintain gains above technical support around 1.2880.

Japan faces a new reality following elections following Shinzo Abe’s Liberal Demoractic Part (LDP) victory in lower house elections. In particular, pressure for more aggressive policy will be sustained given the two thirds majority obtained. Nonetheless, it is not obvious that coalition parties will be as welcoming while some of the rhetoric from LDP leader Abe has already softened.

As the deterioration in the Tankan survey revealed the economic picture is clearly worryingly weak. Trade data over the coming week will be scrutinised to determine the lingering impact of frictions with China as well as the strength of the JPY. On this note, a further increase in asset purchases by the BoJ this week will mean that the JPY is unlikely to retrace its losses very quickly. Nonetheless, USD/JPY will face strong resistance around 84.60.

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