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Foreign Exchange

Dollar in retreat as China pushes renminbi to record high

China’s reported intervention to sell the dollar and a tentative return of risk appetite helped rein in the US currency, but eurozone debt fears kept its losses in check.

Headlines • Fitch downgrades long-term ratings of six global banks (Bank of America, Goldman Sachs, Barclays, BNP Paribas, Deutsche Bank and Credit Suisse)

• Standard & Poor’s downgrades 10 Spanish banks, and remains on watch for a further cut

• Renminbi rises to record high of Rmb6.3294 against the dollar

• Reserve Bank of India adds to FX trading restrictions to stem rise in USDINR

Market reaction

The dollar retreated on Friday as investors paused for breath after a week of sharp gains for the US currency, which was triggered by growing fears over the eurozone debt crisis and its effect on global growth.

Some put Friday’s move down to a run of better-than-expected US economic data, which helped support equities and stem haven demand for the dollar. Speculation that China was to announce a further cut in banks’ reserve requirements also lifted risk appetite.

Others put the dollar’s subdued performance down to action by Asian central banks, with reports that China intervened in large amounts through local banks to push USDCNY to a record low, and action from the Reserve Bank of India to stem losses in the rupee weighing on the US currency.

EURUSD managed to hold above $1.30, although rumours that ratings agencies were preparing to downgrade Spain and Italy kept demand for the single currency in check and within sight of the 11-month low of around $1.2950 that it hit on Thursday.

The better tone in sentiment also helped GBPUSD to pull above $1.5500, while growth-sensitive currencies also found support, with the Australian, Canadian and New Zealand dollars trading on a better footing.

The Swiss franc remained in demand after the Swiss National Bank’s decision not to raise the floor in EURCHF after its meeting on Thursday.

USDJPY traded in a tight range around Y78.00, with the tentative rise in risk appetite weighing on haven demand for the Japanese currency elsewhere.

Positioning

Morgan Stanley’s positioning tracker calculates the largest long positions to be in USD and JPY, while the largest short positions are in CAD and the Skandies.

Morgan Stanley data suggests EUR moved into neutral territory for the first time since September, after heavy buying from Japanese margin accounts on the Tokyo Financial Exchange.

Nevertheless, sentiment on EUR is near all-time lows – 95% of those surveyed were euro bearish.

Although JPY remains net long, it is noteworthy that TFX accounts were large sellers of yen.


 Positioning Tracker score

 
 Source: Morgan Stanley

The Morgan Stanley positioning tracker uses six indicators, including MS proprietary flow, IMM data, Japanese Toshin accounts and Tokyo Financial Exchange flows, betas of currency managers’ and macro hedge funds’ daily returns on currency indices. Flows

Modest selling in USD helped risk proxies stage a mini-revival.

EURUSD moved back above $1.30 overnight as EUR selling eased, although leveraged names were seen to be active sellers capping rallies in the $1.3030-$1.3040 region.

Traders at one top-five bank have expressed a preference for entering short-term tactical long positions, given the magnitude of the sell-off this week. EURUSD has fallen from $1.3375 to sustained sub $1.30 levels. However, traders say entering shorts around the $1.3080-$1.31 level still remains the preferred strategy given the EUR’s inherent weakness.

AUDUSD also consolidated above parity as European accounts pushed for stops in the $0.9990-$1.00 region. The pair moved as high as $1.0019, but offers from short-term and leveraged players at $1.0020 saw Aussie move back down to through $0.9990.

Firmer equity markets and profit taking from sterling shorts provided a supportive backdrop for GBPUSD, which rallied to $1.5540 before sell orders moved cable back under $1.55. Short-term momentum and intra-day players have been keeping cable firmly in a $1.5540-$1.5490 range.

EURCHF moved down to SFr1.2223 early in the London session, though profit-take orders from large macro names that were short EURCHF ahead of the SNB policy decision kept a lid on Swissie rallies. Rumours of very large bids in the SFr1.2220 region, protecting outstanding option barriers at SFr1.2200, may also contain EURCHF downside today.

Options

Implied volatility continues to sell-off. The biggest moves were in AUDJPY and NZDJPY, with one-month vols in the currency pairs falling 2.22 to 14.67 and 14.72 respectively.

EURUSD front-end vols continued their slide. Since the start of the week, one-week vols have come off by 3.25 and are now trading at 11.75, while one-month vols have come off 1.15 down to 12.80.

As a result, the vol curve has become very steep, with the one-year-to-one-month spread now 2.5, the highest level since last April.


 EURUSD implied volatility term structure

 
 Source: Bloomberg

“Deteriorating liquidity going into the year-end means even small trades are pushing vols lower,” says Olivier Korber, derivatives analyst at Société Générale. Furthermore, EURUSD spot has held steady around 1.30 and option desks holding downside digital risk need to sell growing sizes of vanillas when the spot does not move.

“This maintains downward pressure on vols and so we believe the spot/vol connection will weaken further still,” says Korber.

Swaps

Easing tensions in the forwards market saw the premium for borrowing dollars fall, although it still remained at elevated levels. Benchmark EURUSD three-month cross currency swaps narrowed from -147bp to -120bp.

What to look for

EURGBP looks set to break lower, as investors seek out a haven from the escalating eurozone debt crisis.

One of the characteristics of EUR/GBP during the past 15 years has been an extended period of well-defined range trading, while the other is that when these ranges break, the price subsequently tends to trend aggressively for an extended period.

This was true not only of the uptrend that developed in the immediate aftermath of the collapse of Northern Rock, which continued on until the end of 2008 and saw EURGBP rise by more than 40%, but also the periods between October 1996 and July 1997, and January 1999 and May 2000, when EURGBP fell by 18.7% and 17%, respectively.

Simon Derrick, at Bank of New York Mellon, says all three shifts were characterised by rising volatility throughout the lifetime of the moves.

“While these trends might have started relatively quietly, they built in intensity,” says Derrick.

“ Given that one-month historical volatility has just rebounded from its lowest levels since the high in the summer of 2008 and that EURGBP appears to be making a concerted effort to break down out of its well-defined range, it could well be that a similar pattern is going to emerge again.”

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