Anxious wait for Greek PSI

An anxious wait for the outcome of the Greek private sector involvement in a debt swap taken together with a bout of risk aversion and confirmation of weak growth in the Eurozone (Q4 GDP dropped by 0.3%) have set the scene for nervous trading in EUR/USD. Confirmation of the Greek debt swap deadline on Thursday has done little to stead nerves.

The EUR has lost plenty of ground over recent days but will likely consolidate ahead of the outcome of the PSI. Direction will then depend on whether there has been sufficient voluntary participation by bond holders to avoid forcing private sector involvement. In the event of strong participation the EUR will rally but I suggest selling into any such rally.

Another factor that is playing a role in dampening EUR demand is the fact that the European Central Bank (ECB) balance sheet continues to expand at a rapid rate, to a record EUR 3.02 trillion last week following the second ECB long term refinancing operation (LTRO). Overall, expect little respite for the EUR. Effectively the ECB is undertaking quantitative easing via the back door, which is weighing on the EUR in the process.

USD/JPY has pulled back from its highs in the wake of an increase in risk aversion. As I have been noting over recent days the move in USD/JPY had overshot its short term ‘fair value’ estimate according to my quantitative models. The drop in USD/JPY fits into line with this view. The fact that US bond yields have pulled back from recent highs has also played into the drop in USD/JPY.

While I remain bearish on the JPY over the medium term, there is scope for a further move to technical support the 80.00 level in the short term. Further out, much will depend on the ability of Japanese officials to follow through on more aggressive policy to reflate the economy.

The Bank of Japan’s inflation goal will need a determined effort in terms of more aggressive monetary policy to enable it to succeed. This will ensure that Japanese government bond yields remain suppressed at a time when I expect US bond yields to move higher. Consequently USD/JPY will likely move higher too, with my year end target remaining at 85.00.


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