The first month of 2012 passed rather more positively than anticipated and clearly was a good month for risky assets. Even the beleaguered EUR strengthened despite calls for an extended decline. Assets that were most heavily sold over 2011 were the biggest winners over January. Further signs of improvement in US economic data, receding fears of a China growth crash and even signs of tentative progress in the Eurozone debt crisis mean that sentiment may have finally turned a corner. This has been reinforced by the Fed’s commitment to maintain accommodative monetary policy until the end of 2014 and the ECB’s long term LTRO. I’m not entirely convinced but it wouldn’t pay to buck market optimism just yet.
Interestingly currency markets aren’t necessarily behaving as one would expect. In particular the JPY and CHF, both safe haven currencies, have not weakened despite an improvement in risk appetite. In contrast they have actually strengthened. Other currencies are behaving much as would be expected, especially high beta (risk sensitive) currencies, including AUD, NZD and many emerging market currencies, which have rebounded. Even the EUR has jumped past the 1.30 mark against the USD. Even the slow progress in agreeing on the magnitude of Greek writedowns has failed to dent confidence, with Eurozone peripheral bond yields dropping. Risk / high beta currencies are set to remain well supported over the short term.
Looking ahead the outcome of the US January jobs report at the end of the week as well as a final agreement on Greek debt will help determine whether the positive sentiment for risk assets will be maintained into next week. Meanwhile the USD looks as though it will remain under pressure especially given the continued downward pressure on US bond yields, which only continues to reinforce its role as a funding currency. This explains why both the JPY and CHF have stubbornly refused to weaken as narrowing US versus Japanese and Swiss bond yield differentials have kept these currencies under upward pressure. However, risks of FX intervention by both the Japanese and Swiss authorities suggests that upside may be limited.