Risk currencies buoyed

Positive developments helped to buoy markets. Although US durable goods orders were weaker than forecast a jump in US consumer confidence to its highest since February 2011 gave equity markets and risk assets in general a lift. Even in Europe the news was encouraging as Italy managed to auction 10-year debt at a cheaper rate than previously while Portugal passed a third review of its bailout programme and noted that unlike Greece it would need a second bailout.

There was some negative news however, with the European Central Bank (ECB) temporarily suspending the eligibility of Greek bonds as collateral for its funding operations and Ireland calling a referendum on the European fiscal compact. Nonetheless, hopes of a healthy take up at today’s ECB second 3-year Long term refinancing operation (LTRO) will keep markets in positive mood in the short term.

The USD index continues to look restrained when risk assets are rallying. Given the positive equity market mood overnight it is no surprise that the USD came under further pressure while the EUR looks firm ahead of today’s 3-year LTRO by the ECB. Fed Chairman Bernanke’s testimony will give the USD some direction but we do not expect him to deliver any big surprises. EUR/USD will continue to rally if we are correct about a strong EUR 600-700 billion take up at the LTRO but the currency pair will meet resistance around 1.3550.

JPY has lost ground against various cross including USD, EUR and AUD. Much of its weakness is related to widening yield differentials but our models reveal that USD/JPY in particular has overshot its implied value. Unless US yields widen further versus Japan, JPY could even rebound over coming days. EUR/JPY has breached its 200 day moving however, which is a bullish signal for the currency pair. A generally firm EUR tone likely to be maintained in the short term will also be exhibited versus JPY.

Warnings by Swiss National Bank head Jordan reiterating his stance of defending the EUR/CHF floor of 1.20 has done little to push the currency pair higher. EUR/CHF has enjoyed a strong relationship with movements in interest rate differentials. This implies that it will take a relative rise in German yields versus Swiss yields for EUR/CHF to move higher. This is certainly viable given the deterioration in Swiss economic data over recent months. Eventually EUR/CHF will move higher but over the short term it is unlikely to move far from the 1.20 level.

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