Roller Coaster Foreign Exchange Market, but Ride the Dollar

After falling in Asia to new lows since October 10, the euro rallied in  Europe, briefly turned positive on the day, before coming off hard.  The short squeeze higher seemed to be largely based on what will likely be proven untrue.  There were reports and speculation that the ECB would agreed to defend certain interest rate spreads for the periphery.  This would commit the ECB into unlimited buying, which it does not want to do and some say is illegal for it to do.  It also confuses why the ECB buys sovereign bonds in the secondary market; not to defend a rate (e.g. 7%), but to ensure the transmission of monetary policy. 

Some suspect that China is getting ready to ride to Europe's rescue.  This also does not seem very likely.  Europe has sufficient assets and wealth to address the crisis.  It requires hard choices, but if they do not want to buy their own bonds, why should China?  EFSF bonds have performed worse than bunds, so it is hard to make a case based on performance, liquidity or transparency. 

The talk that seems most likely to be true is that the ECB may have stepped up its bond purchases, but the impact does not seem to be lasting as the Italian 10-year bond is back at 7% and France and Spain have bonds to sell tomorrow. 

The euro's bounce ran out of steam near $1.3560 and quickly surrendered the early gains.  Although some may see support near $1.34, the risk is a return to the early Oct low near $1.3150.  News that Moody's was placing Unicredit on credit watch may have been the cold slap by reality.  Moody's had slashed Unicredit ratings last month three notches to A2.    Yesterday S&P downgraded the Andalusia region in Spain to A+ from AA- (more shortly on Spain in another post). 

News from Germany did not help matters.  It was trying to sell up to 6 bln euros of new 2-year bonds.  It managed to sell 5.455 bln.  The yield was a record low of 39 bp, down 7 bp from last month's sale.   The Germany 2-year note is under-performing with the generic 2-year yield up 8 bp on the day and this is impact the US-German 2-year spread. 

The other main development in Europe today comes from the UK.  The employment data was a little better than expected, but this did not help sterling as much as the dovish quarterly inflation report weighed on it.  The pessimistic economic outlook and expectations of a sharp drop in price pressures essentially signaled the BOE will extend the asset purchase program when the current operation is completed.  

Sterling now faces resistance in the $1.5800-50 area.  Initial support is seen near $1.5720 and a could spur another cent downdraft. 

The Bank of Japan's two day meeting ended without action.  However, it did cut its economic assessment, with an eye toward the unsettled global environment.  If the dollar has been on a roller coaster ride in Europe, it has been like waiting in line when it comes to the yen.  The dollar has been confined to a 15 tick range on either side of JPY77.00

The dollar-bloc currencies and the Scandis seem to be tracking the euro and this seems to be much more important than domestic developments.  Typically, when the US dollar is firm, the Canadian dollar tends to outperform on the crosses.