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Foreign Exchange

Real money shuns liquidity-driven party

Good demand at a Spanish bond auction helped underpin the euro, but the stellar rally in risk correlated currencies stalled as real money investors shunned the liquidity-driven party laid on by global central banks.

Headlines

• Asian stocks surge higher after Wednesday’s coordinated policy move

• Spain sells €3.75bn of bonds amid strong demand at auction with the offering almost three times covered

• France sold a total of €4.35bn at yields between 2.42 per cent and 3.94 per cent.

• China official manufacturing PMI fell to 49.0 in Nov from 50.4 in Oct, the weakest reading for three years

• The eurozone November manufacturing PMI was confirmed at 46.4, down from 47.1 in the previous month

• U.K. November CIPS manufacturing PMI was better than expected at 47.6

• ECB’s Draghi warns on growth, but says the central bank’s bond purchases can “only be limited”

• Australian retail sales below forecast with 0.2% rise in October, building approvals fell 10.7% Oct

• Brazil cut rates by 50 basis points to 11%.

Market reaction

The dollar stabilised on Thursday, after the explosive price action in the previous session. The sharp rally in risk-correlated currencies after the coordinated move by global central banks to ease funding tensions stalled as the reality set in of the grim prospects for global growth.

Asian equities surged higher as investors in the region reacted to Wednesday’s decision by the Federal Reserve to boost dollar liquidity through enhanced swap arrangements with other central banks, but the move had largely played itself out in the currency markets.

Many analysts saw the liquidity boost, while welcome, as not representing a cure for the underlying problems of insolvency at sovereign level that have been unsettling markets.

EURUSD, which surged more than 200 pips higher on Wednesday, held on to its gains but failed to break up through $1.3500.

While good demand at Spanish and French bond auctions offered the single currency some support, weak eurozone manufacturing data reinforced the view that the region was headed for recession, and heightened speculation that the European Central Bank would cut rates at its December policy meeting.

AUDUSD came under early selling pressure, pulling back from Wednesday’s high above 1.03, as weak domestic and Chinese data raised the prospect of further monetary easing from the Reserve Bank of Australia.

GBPUSD broke up above $1.57, after UK manufacturing data came in stronger than forecast, while USDJPY remained in a tight range just below Y78.

Flows

There was little sign of fresh euro long positioning from real money. Short-term range trading is likely to prevail on an intra-day basis with sell orders at the 1.3500 pivot, while support is seen at 1.3400-20 and 1.3370-80 area. There were reports of option-related buying keeping EURUSD in a narrow range around 1.35 (see options section).

Traders say large-scale interest is limited after yesterday's deep euro short covering, after the central bank liquidity moves.

Losses on the downside were contained by a supranational bank, suggesting some sovereign activity provided support on the margin.

In AUDUSD, leveraged names used yesterday’s rally as a selling opportunity, particularly on the back of the weak Chinese PMI number. Bank names were seen as decent buyers of AUDNZD, while corporates looked to have completed the majority of their month-end hedging.

However, by mid-morning, AUDUSD staged a small rally up to 1.0240, as European equities encouraged short-term account buying. Resistance was expected at 1.0250, with sell orders from macro traders.

CAD saw ongoing rally sellers despite good price action and a strong Q3 GDP data.

Positioning

With the dust settled in the wake of Wednesday’s coordinated central bank intervention in the swaps market, positioning indicators from top-tier banks shows a substantial reduction in the EUR short.

The market has moved towards more neutral territory, with the EUR short now at the lowest level since mid-August on one bank’s platform.

While yesterday’s positive move flushed out several shorts, few outright longs were re-instated. As year-end approaches, strategists say investors are unlikely to put on fresh longs in the absence of constructive political developments in Europe.

As expected, the dollar long was cut back across most currencies, as investors positioned themselves in riskier assets.

Despite fears of a global slowdown and weakening Chinese PMI, it seems the market is still long oil currencies, with longs still firm in CAD, NOK, MXN, RUB.

Shorts in JPY and GBP, however, seemed relatively resilient.

Sterling positioning has been among the most volatile recently but in the past two weeks it seems the market has made up its mind it wants to be short.

Swaps

Funding tensions continued to ease, with the premium for obtaining dollar funding heading lower after the move from global central banks to ease liquidity strains.

The three-month EURUSD cross currency basis swap narrowed to -116bp from a close of -130bp on Wednesday. Ahead of the move from global central banks on Wednesday, it had hit -162bp, a post-Lehman high.

Options

FX vols remain offered following global central banks’ moves to ease liquidity conditions. 1m vols are trading at their median levels – based on data for the last six months – while vega remains close to its highs.

Selling pressure in the front-end led to more steepening, but traders maintain the view that there will only be temporary relief, especially in EURUSD vols unless the co-ordinated action from central banks is the first of a set of strong new monetary measures.

Yet risk reversals did not react excessively to Wednesday’s jump in spot EURUSD from $1.33 to $1.35, moving just 0.1 lower from the level seen two days ago.

Meanwhile, there were rumours of a large European digital option expiry at $1.3500 in EURUSD, in which the holder will receive a payout if spot remains in a certain range around the price. Dealers said that should keep spot contained in a range around $1.35.

What to look for

While Wednesday’s central bank intervention in the swaps market eased fears on bank funding issues, the eurozone issues remain far from resolved and data on the global economy looks to be progressively worsening.

Wednesday’s risk rally was most heavily felt in the commodity bloc, with AUDUSD rallying through 1.0300, almost 50% more than the 200 pip rally in EURUSD. But as the euphoria of concerted central bank intervention dies down, the weak macro outlook will return to the fore and will once again weigh on high-beta currencies.

Chinese and Australian PMIs as well Australian retail sales were disappointing and the fundamentals supporting the Aussie now look considerably weaker than they did last week when AUDUSD was looking heavy in the 0.97 region. With this in mind, rallies up to the morning highs around 1.0250 may offer inviting sell opportunities for a fragile AUDUSD.

Spot, 6.30 EST

 
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