Market attention remains fully focussed on events in Japan especially related to the country’s nuclear facilities. Risk aversion has spiked higher as a result, with ongoing Middle East tensions adding to the risk off tone. CHF is a key beneficiary of safe haven demand but the picture for JPY is obscured by repatriation expectations on one hand and FX intervention risks/Bank of Japan liquidity injections on the other, keeping USD/JPY clsoe to the 82.00 level. In contrast the AUD is vulnerable to a drop below parity with the USD on Japan worries, especially as Australia is a key destination for Japanese investment and therefore potential for reversal of such flows if Japanese institutions repatriate funds.
The EUR recovered over recent days as worries about the eurozone periphery ease and peripheral bonds spreads narrow. It is only a matter of time before overly long market positioning catches up with the EUR especially as the prospects of further interest rate support to the currency looked limited; markets have already priced in 75bps of policy rate hikes in the eurozone this year, which looks appropriate. It is difficult to see markets pricing in any more tightening than this over coming weeks. Despite its bounce back EUR/USD will struggle to break resistance around 1.4036.
Markets will digest the fallout from the informal EU leaders meeting last Friday which prepared the groundwork for the official meeting on 24/25 March. The initial reaction of the EUR appears to be positive but there is a significant risk of disappointment if the outcome of the meeting on 24/25 March does not live up to expectations. Indeed although Friday’s meeting resulted in an agreement in principle of a new “pact for the Euro” much will depend on the eventual details later this month.
Leaders also agreed on lowering interest rates to Greece by 100bps, and in principle enlarging the scope of the European Financial Stability Facility (EFSF) bailout fund to EUR 440 billion. The main positive surprise was opening the door for the fund to purchase eurozone debt. Data releases will offer little support to the EUR this week, with limited gains in the March German ZEW investor confidence survey today likely to leave markets unperturbed.
The USD’s gains last week proved short-lived and the currency will be tested by another relatively dovish Fed FOMC statement today and a benign reading for core CPI inflation in February. The Fed FOMC meeting is unlikely to deliver any changes to the Fed’s stance and whilst there has recently been some speculation that the Fed will soon remove its “extended period” comment, this is unlikely to happen any time soon. The statement will remind markets that the Fed is in no rush to alter its policy settings, an outcome that may limit the ability of the USD to strengthen this week even if data releases continue to remain on the positive side, including manufacturing survey and industrial production over coming days.