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Foreign Exchange

China rides to the euro’s rescue

The euro reversed early losses on reports that China was to create a new fund to invest in Europe, while speculation surfaced that Japan was covertly intervening to weaken the yen.

Headlines • China to create $300 billion FX investment vehicle, part of which will be focused on investment in Europe - Reuters

• 17 eurozone countries agree fiscal compact as proposed by France and Germany; deal to be put in place by inter-governmental treaty

• Agreement will not include all 27 EU members, although some others may sign up

• UK and Hungary do not want to take part; British prime minister describes deal as not in the country’s interest

• The ECB is to manage the EFSF and the ESM; ECB president Draghi says the summit had a “very good outcome”

• The ESM will not be granted a banking licence and will initially be capped at €500bn

• EU countries are planning to provide €200bn in extra funding to the IMF; Sarkozy says he wants a decision within a week

• Chinese consumer price inflation falls to 4.2% in November, down from 5.5% in October

• Japan revises down Q3 GDP growth to an annualised 5.6% from an initial 6%

• The Bank of Korea cuts GDP growth rate estimate for this year to 3.8% from 4.3%

Market reaction

EURUSD surged higher through $1.34 on reports that China was to create a new $300bn fund, and would invest part of its money in Europe.

The news reversed an earlier move that saw EURUSD fall back from its highs, and stocks came under pressure as news from the EU summit in Brussels disappointed investors.

The news that all 27 EU members had failed to reach an agreement, with the UK and Hungary refusing to take part, pulled EURUSD down from an intra-day high at $1.3372 down below $1.33.

Developments in Brussels did little to lift sentiment towards the euro, which was hit on Thursday after ECB president Mario Draghi quashed hopes that the central bank would step up its peripheral government debt purchases.

However, with EU leaders having averted complete disaster for now, EURUSD did not gather downward momentum and bounced back sharply on the reports from China.

USDJPY remained around ¥77.70 after a sharp rebound in Thursday’s session raised speculation of covert intervention from Japan to weaken its currency.

AUDUSD came under pressure, with news of a continued economic decline in Asia helping to cap demand for the currency. Other commodity-linked currencies also suffered, with the NZD and CAD falling back from their highs.

Declining risk appetite lifted the USD and JPY broadly, while the CHF also benefited from unease over the euro, with EURCHF trading down through SFr1.2350.

GBPUSD failed to benefit from the UK’s decision not to take part in the EU agreement. While Britain’s decision should shield the City of London from a planned transaction tax, GBPUSD took its lead from the swing in risk appetite.

Flows

USDJPY: Nervousness over covert intervention from the Bank of Japan remained in the market after a sharp squeeze of short positions on Thursday, fuelled by the belief that the BoJ could be present in the market below ¥77.00. USDJPY shot up after hitting a low of ¥77.32 on Thursday, stabilising about ¥77.70 on Friday.

Traders said the possible covert intervention, which was also believed to have been carried out in the early days of November by the BoJ, appeared to be having a greater influence than the large overt intervention that took place on October 31.

EURUSD: A top-five bank saw bias for selling during early London session, although volumes remained average.

Another bank says a move down towards $1.33 was hampered, as short-term players covered short positions placed to take advantage of any negative surprises from the summit in Brussels.

AUDUSD: The currency pair took the brunt of selling as risk appetite declined, having hit a high just below $1.0300 on Thursday amid heavy sovereign demand for the AUD. But AUDUSD plunged to a one-week low of $1.0090 on Friday.

Positioning

The aggregation of spot FX flows on Barclays’ BARX platform during the past month, up until December 7, indicates – along with most traders’ general perception – that the market is still very short EUR and long USD. Barclay’s flow data suggest the market is still long JPY but broadly flat GBP, CHF and AUD.

Swaps

EURUSD FX forwards moved to the right, although traders said it was more a reflection of worries over the euro than concerns over European banks’ funding.

Indeed, funding stress appeared relatively contained after the ECB’s decision on Thursday to launch a range of new non-standard measures to help eurozone banks obtain liquidity.

However, traders said worries over the euro had heightened after the ECB’s indication that it was not set to enlarge its bond-buying programme and become Europe’s lender of last resort.

This was reflected as benchmark three-month EURUSD cross currency basis swap widened to -127bp from -116bp on Thursday, still some way off the post-Lehman record of -162bp.

What to look for

“Long USDCHF has the potential to be a great trade in this environment,” says Sara Yates, FX strategist at Barclays Capital, which was echoed in the bank’s global outlook report for 2012.

The reason being is that there is likely to be upward pressure on USDCHF in both a deterioration or improvement surrounding the resolution of the eurozone crisis, according to Barclays strategists.

In the event of good progress in the eurozone crisis, the Swiss franc is likely to become less important and will depreciate against the euro, while at the same time relative outperformance of US economic growth compared with Europe will return to the fore, weighing on the euro. The likely result would be moves higher in USDCHF.

In the reverse case where things deteriorate in the eurozone and risks of financial Armageddon mount, investors will ultimately flock to the safety of the US dollar – not the Swiss franc. Whether or not the SNB decides to raise the EURCHF floor, on a risk-reward basis, USDCHF might offer investors a lucrative medium-term to long-term trade.


Spot, 06.45 EST

EUR: Current: 1.3422 Open: 1.3345 Support: 1.3280 Resistance: 1.3450

GBP: Current: 1.5699 Open: 1.5630 Support: 1.5600 Resistance: 1.5700

EURGBP: Current: 0.8545 Open: 0.8539 Support: 0.8500 Resistance: 0.8600

CHF: Current: 0.9188 Open: 0.9260 Support: 0.9180 Resistance: 0.9330

EURCHF: Current: 1.2333 Open: 1.2355 Support: 1.2330 Resistance: 1.2430

JPY: Current: 77.70 Open: 77.00 Support: 77.12 Resistance: 78.29

EURJPY: Current: 104.38 Open: 103.60 Support: 102.50 Resistance: 106.20

AUD: Current: 1.0153 Open: 1.0170 Support: 1.0000 Resistance: 1.0310

NZD: Current: 0.7698 Open: 0.7720 Support: 0.7600 Resistance: 0.7910

CAD: Current: 1.0207 Open: 1.0230 Support: 1.0150 Resistance: 1.0300

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