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Foreign Exchange

Firewall speculation can’t protect euro

Initial support for the euro evaporates as a German official torpedoes talk of doubling the financial firewall around the eurozone.

Headlines • EU talks on doubling financial firewall, as summit set to debate the running of two separate rescue funds and winning increased support from the IMF – Financial Times

• Senior German official says “can’t forsee” running EFSF and ESM simultaneously - Reuters

• Australia Q3 GDP rises 1.0% q/q versus 0.8% consensus

• UK industrial production -0.7% in October, worse than -0.3% expected

• Strong demand in German five-year bond auction, with bids for the €5 billion on offer amounting to €8.670 billion

• ECB allots $50.685bn in its 84-day swap operation

Market reaction

EURUSD advanced as a report suggested that EU leaders were considering doubling the eurozone’s rescue fund to €900 billion and using the EFSF and the ESM in tandem in a bid to ring fence the region.

That said, scepticism over where the funds would come from and caution ahead of the EU leader's summit on Friday, and the European Central Bank’s meeting on Thursday kept the EURUSD’s gains in check around $1.3450.

EURUSD was then pulled lower as reports hit the newswires that German officials rejected the combined use of the eurozone’s rescue vehicles, sending it down to the $1.3370 region.

Meanwhile, investor sentiment was lifted after Australian growth figures came in stronger than expected. That helped to maintain the mildly bullish tone in equity markets and push AUDUSD up towards $1.0300.

Other risk-correlated currencies also benefited, with NZD and CAD advancing, while GBPUSD held above $1.5600 despite much worse-than-expected industrial production data. CAD also found support from a less dovish tone from the Bank of Canada (see what to look for, below).

Meanwhile, EURCHF maintained a firmer tone above CHF1.2400, as rising Swiss unemployment heightened speculation that the Swiss National Bank was set to raise the floor in the currency pair after next week’s policy meeting.


The Bank of New York Mellon’s iFlow report, which captures the direction and magnitude of net currency flows through its custodian bank, showed continued outflows in EUR everyday this week.

Indeed, cumulative net outflows in EUR were the largest of any currency.

Dollar flows ebbed slightly but remained positive, while cumulative outflows in AUD receded this week.

The direction of JPY flows reversed from a firm outflow last week to decent inflows, matching the positive flow into Japanese fixed income markets. Flows in GBP, CHF and MXN were all largely neutral.

Strong flows into equity markets in Brazil, Mexico, South Africa and Asia explain the positive inflows in their local currencies.


Traders noted lower interest in EURUSD ahead of the coming event risk from EU summit – with the market still short, the risk of a short-covering rally ahead of Friday’s summit is viable. Cautious optimism after reports of a doubling of the eurozone bailout funds buoyed EURUSD above $1.34 but met resistance at the $1.3450 level before a German official disregarded the validity of the report sending EURUSD to 1.3380.

EURCHF saw a burst of buying after Swiss unemployment numbers in November came in at 3.1%, up from 2.9% in October, yet more confirmation of a weakening Swiss economy and providing further stimulus for a rise in the exchange rate floor.

EURCHF moved as high as SFr1.2443 before encountering strong options-related selling to protect SFr1.2450 barriers.

Demand for AUDUSD was mooted despite third quarter Australian GDP growth at 1% beating consensus estimates. Traders at the top five have said selling offers at $1.0300 will cap upside moves while buy orders below $1.0150 will keep the pair in a contained range ahead of the EU summit.

Traders at one bank noted Japanese real money USDJPY buying but, other than that, interest was subdued, with the pair remaining in a narrow ¥77.77-77.60 range throughout the Asian and early European session.


The ECB allotted $50.685billion in its 84-day swap operation, the first since global central banks last week announced a cut in the rate at which dollars would made available through the facility.

The take-up was a lot higher than the $10billion expected, and eased some tensions in the funding market.

The benchmark three-month EURUSD cross currency basis swap initially narrowed to -108bp, from -115bp at the open, before settling back around -111bp. That was a lot narrower than the post-Lehman record of -162bp the swap hit last week ahead of the decision by global central banks to inject dollar liquidity.


Options traders have noted good demand from fast money for 1w and 2w dated EURCHF Sfr1.2500 strikes, to cover this week’s EU summit and the December 15 SNB meeting.

However despite EURCHF vols moving lower they have actually become expensive relative to where vol was realising.

Derivatives strategists at Morgan Stanley say volatility trades in AUDCAD are compelling as vols are well below average – though not extreme –on both an outright and a vol adjusted basis.

Implied volatility relative to realized is near the post crisis lows although outright levels will have to go lower to justify going outright long vol.

AUDCAD 3m implied vol 

 Source: Morgan Stanley

Morgan Stanley strategists say investors looking to get positioned for AUD weakness should consider buying puts on the AUDCAD cross. What to look for

There looks to be value in the Canadian dollar, the worst performing major currency so far this year.

The Bank of Canada left rates on hold at 1% after its policy meeting on Tuesday, but was less dovish than expected. The BoC remained cautious, but talked about more robust growth in the US and stronger growth than forecast in Canada in the second half of the year.

Economic figures bore out this more optimistic view, with the Ivey November PMI surging more than 10% higher to 59.9, well above expectations and reflecting the resilience in Canadian economic growth.

The BoC may not hike rates in the foreseeable future, but, unlike its peers, it is unlikely to ease monetary policy any time soon.

Rabobank, which says the CAD could also benefit from rising oil prices triggered by tensions in Iran, suggest a two-pronged approach to benefit from gains in the currency.

In a risk off environment, sell EURCAD on rallies, the bank says; in a risk on environment, expect USDCAD to push back towards parity.

Spot, 6.45am, EST

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