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Foreign Exchange

Euro surges as banks load up on Spanish paper

The euro pulled away from its lows as banks scrambled for Spanish government debt to pledge as collateral in exchange for long-term funding from the European Central Bank .

Headlines • Demand surges at Spanish bill auction; six-month yield at 2.4355% versus 5.277% at previous sale

• EU fails to meet €200 billion target to fund the International Monetary Fund

• Germany’s Ifo December business confidence index rises to 107.2, better than expected 106.0

• UK Nationwide consumer confidence rise more than forecast in November

• Japan announces increase in intervention war chest to ¥195 trillion from ¥165 trillion

• Japanese finance minister announces Tokyo in talks to purchase Chinese government debt to strengthen economic ties

• Reserve Bank of Australia minutes more hawkish than expected, citing solid growth in Asia and China

• Riksbank cuts rates by 25bp to 1.75%, citing deteriorating global economy

Market reaction

A better-than-expected reading of the German Ifo index helped EURUSD to hold above $1.30 on Tuesday, while good demand at a Spanish bill auction helped the single currency extend its gains.

Traders said a large portion of the demand for Spanish paper was likely to be linked to banks building up collateral ahead of Wednesday’s three-year long-term refinancing operation (LTRO) by the European Central Bank.

GBPUSD also advanced as above-forecast UK consumer confidence figures lent sterling support.

Meanwhile, the dollar came under pressure as risk appetite stabilised after Asian equities rebounded after a sharp fall in the previous session.

The Korean won, which tumbled more than 4% against the dollar on Monday, recovered all the knee-jerk losses it suffered after the death of North Korean leader Kim Jong-il over the weekend.

AUDUSD advanced after the minutes of the Reserve Bank of Australia’s December meeting were less dovish than expected. The central bank pinned the blame for last month’s rate cut on problems in Europe, but emphasised the relative strength of Asian economies.

EURSEK fell after Sweden’s Riksbank cut rates by 25 basis points to 1.75%, confounding expectations in some quarters that the central bank would deliver a 50bp move and forcing investors to cut short positions in the krona.

Elsewhere, USDJPY held steady under ¥78.00, but action by the Japanese government to raise its intervention arsenal put traders on alert for further intervention to weaken the currency.


Reports of heavy Middle Eastern interest in EURUSD outweighed offers from Asian accounts at $1.3020 and news of a successful Spanish auction triggered buy stops through $1.3050, sending EURUSD as high as $1.3178. Traders said a cluster of offers that lies at $1.31 may limit further gains.

Dealers said overstretched short positions may have partially contributed to the move, though there is little evidence of any build up in long positions ahead of $1.31.

Strike congestion in the options market around $1.30 is also likely to restrict movement away from these levels.

AUDUSD rallied more than 50 pips, reaching $0.9981 as intra-day traders piled in after the RBA minutes were less dovish than expected. The pair remained buoyed in a relatively well-bid environment, though was unable to reach the parity mark.

NZDUSD also advanced on the back the Aussie rally and corporate hedging ahead of the Christmas period.

EURCHF was unable to hold on to gains above SFr1.22 despite good demand from Swiss macro accounts.

EURCHF has now become less of a one-way bet, with the pair probing SFr1.2150 as the SNB’s decision not to raise the floor induced a return of haven-related flows.

Although there has been talk of tentative inclination to test the floor, very good bids remain in place between SFr1.2170 and SFr1.2150, with the SNB itself purported to defend the SFr1.21 figure ahead of the SFr1.20 floor.


Cumulative flows at UBS show investors are positioning for safety heading into the year end with JPY, GBP, USD and CHF net bought last week. Every other risk proxy, including the EUR, was net sold.

Unsurprisingly, positioning in the Swiss franc is likely to have moved into more neutral territory after a steady building of shorts in anticipation of a rise in the EURCHF floor last week.

The Bank of New York Mellon’s iFlow monitor confirmed continued EUR outflows, while inflows into USD, JPY and GBP were firmly in positive territory. CHF flows were largely flat, as were risk proxies AUD, NZD and CAD, as investors squared currency positions into the year end.


Euro vols changed little on Tuesday, as the euro spot sat in a range due to a general lack of volume.

One-month risk-reversals moved below two vols, as the market digested EURJPY gamma from the previous week, with few players looking to add to the downside given the barriers still in the market, traders said.

With short-end vols coming off elevated levels, traders said there is less value in RKO downside structures now, and is almost reaching the point where buying downside on its own makes more sense. In fact, one-month downside has moved back to levels not seen since September.

AUDUSD implied vols looked cheap, with three-month implied trading a touch under 16%, while one-month and three-month realized were 17.2% and 20.875% respectively.

 AUD 3m implied volatility vs 1m and 3m realised


Swaps Tensions in the funding market eased as investors awaited the ECB’s three-year LTRO on Wednesday.

Eurozone banks were expected to borrow up to €400 billion, securing funds that will be useful as Basel III and liquidity coverage ratios come to into force in the run-up to 2013.

The benchmark three-month EURUSD cross currency basis swap stood at -115.5bp, down from -155bp on Wednesday.

What to look for

Don’t go home short of USDJPY over the holiday period – that would seem to be the message from Japan, after the government raised the amount it is allowed to borrow from the market to finance foreign exchange intervention on Tuesday.

The government raised its war chest from ¥165 trillion to ¥195 trillion. Given that Tokyo had only used up about ¥130 trillion of its original fund, that leaves it with a substantial ¥65 trillion still to deploy.

Further easing from the Bank of Japan after its policy meeting on Wednesday could well usher in massive foreign-exchange intervention to weaken the yen in holiday-thinned markets during the coming week.

Spot, 6.30am, EST

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