Headlines • S&P puts 15 eurozone countries on ‘negative watch’, citing systemic stresses in the eurozone
• Reserve Bank of Australia cuts rate by 0.25% to 4.25%; forecasts slowing Chinese and global growth
• PBoC may “further cut” the RRR at around the Chinese Lunar New Year which falls in late January - China Securities Journal
• Swiss November CPI falls 0.5% y/y, lower than predicted 0.3% fall
• Eurozone GDP rises 0.2% in Q3, 1.4% y/y and in line with forecasts
• UK BRC like-for-like sales fall 1.6% y/y in November versus -0.5% expected.
Market reaction
Any optimism generated by news that Merkel and Sarkozy had agreed on a common proposal regarding the future path for fiscal governance in the eurozone ahead of the EU Summit this week was short lived.
Risk sentiment took a hit following the decision by Standard & Poor’s to place all remaining eurozone countries on credit-watch. Although the decision was hardly a surprise given recent events in the eurozone, the timing ahead of Friday’s summit was.
EURUSD fell to a 6 day low of $1.3337 and Asian and European stock markets and risk-correlated currencies fell.
The Reserve Bank of Australia met market expectations by cutting rates by 25bps but the negative comments surrounding a Chinese slowdown, weakening global growth and a broad negative risk backdrop caused AUDUSD to lose over a cent in the Asian session. AUDUSD hit a low of $1.0156, which initially met demand though the pair struggled to stay above $1.0200 as further selling weighed on the risk proxy.
The Swiss CPI was eagerly anticipated, with a below consensus reading seen as further grounds for the Swiss National Bank to tighten it’s FX policy and raise the exchange rate floor in EURCHF. EURCHF jumped almost 50pips when the worse-than-expected figure hit the wires and hit a 3-week high of CHF1.2418 as markets priced in an increased likelihood of a 1.25 EURCHF floor.
A general pick up in dollar demand saw GBPUSD drift lower towards the support level of $1.5590 where it met corporate and sovereign bids.
Positioning
Market still short EUR and commodity bloc; long USD and JPY
The latest IMM data from the CFTC shows the market was close to a record short in EUR up until November 29. While last week’s gains in optimism following the co-ordinated central bank move to ease funding pressures saw some aggressive short-covering, banks’ proprietary data and recent flows indicates the market is still firmly short of the euro.
The market appears to be long dollars against virtually every G10 currency, barring JPY which latest flows indicate is still in net long territory.
Positioning data in commodity and oil currencies has become shorter, with NZD having moved to a net short from previous neutral levels according to the IMM data and bank’s in-house analytics.
CAD is still a firm short while, market positioning in CHF has moved away from neutral levels as the market increasingly prices in the possibility of a rise in the EURCHF exchange rate floor.
Flows
EURUSD met strong bids at $1.3330 rumoured to be protecting options strikes ahead of $1.3300. Traders say overstretched short positions are capping the downside while intra-day players are said to be sellers in rallies over $1.3400-50.
Lower UK BRC retail sales and weak house price data failed to have a lasting impact on GBPUSD as selling ran into corporate orders around $1.5590-$1.5600. Cable largely sidelined, driven by EURUSD movements, with greater focus on the EURGBP cross.
Traders say in EURGBP, £0.8600 is still a very firm resistance level in a weak EUR environment while the recurring theme of corporate hedging bids in the £0.8520-£0.8550 region offer support.
“A break of £0.8520 should see increased momentum on the downside through it is hard to see this coming from GBP strength,” said one trader. “UK industrial production figures on Wednesday and a Bank of England meeting on Thursday are likely to weigh on sterling.”
In AUDUSD, light stops triggered at $1.0200 and $1.0190 paved the way to the $1.0160 lows before running into corporate bids. AUDJPY met Japanese retail selling around Y80.00 targeting a break through the Y79.00 support level.
USDJPY was contained between Y77.85 and Y77.65. Japanese corporate selling around Y77.70 was countered by demand targeting a break back through Y78.00. A trader at one top-5 bank says the order book indicates decent selling interest above Y78.00 up to Y79.00 and lighter bids down to the low Y77s.
Options
Exotic trades in EURUSD options in the form of puts with downside knock-outs in the $1.25-$1.33 region are expiring in less than a month. The buyers of these knock-out options are short vega, while the options desks that have sold these structures have long vega exposure to hedge.
This has required them to be short volatility on the downside and is one reason explaining why shorted dated EURUSD risk reversals are so cheap according to Societe Generale’s derivatives strategist, Olivier Korber.
If the knock-out is triggered options desk must unwind their hedges as the option no longer exists, however as we enter the low liquidity period, there will be increasing difficulty in unwinding these hedges which will exacerbate moves in vol of vol.
“We therefore expect short-dated vols to pick up significantly if the euro initiates a year end downtrend” says Korber.
| EURUSD 25delta risk reversals |
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| Source: Bloomberg |
Swaps
Funding strains remain in evidence with figures showing eurozone banks parked E328billion with the European Central Bank overnight.
Although down slightly from Friday’s record of E332.7 billion, it is still at extreme levels, showing that fears over counterparty risk – rumours continue to circulate that a major European bank is close to collapse – remain high.
The benchmark EURUSD three-month cross currency basis swap narrowed slightly to -116bp, but still highlights the premium on dollar funding despite global central banks’ move last week to inject liquidity through their swap operations.
What to look for
The final piece of price data ahead of the Swiss National Bank’s meeting on Dec 15 showed Swiss CPI came in much weaker than expected, falling 0.5 per cent in November and all but confirming that Switzerland will suffer from deflation in the fourth quarter.
Recent activity data has shown the Swiss economy is struggling with the strength of the CHF, and Tuesday’s news serves to underline expectations that the SNB will raise the floor in EURCHF once again to protect its economy from its current level of 1.20.
UBS expects the SNB to raise the floor to EURCHF1.25, but others believe the central bank will be bolder given that interest rates are close to zero and the exchange rate is its only policy option to boost the economy. Given recent history, a move to EURCHF1.30 on December 15 cannot be ruled out.
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