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Foreign Exchange

Dollar on defensive as markets embrace holiday spirit

The currency markets headed into the holiday season in a relatively upbeat mood, with encouraging US data weighing on haven demand for the dollar and lending support to riskier currencies.

Headlines • Banks deposit €347 billion in the ECB’s overnight facility, a fresh 2011 high

• Outgoing ECB council member Lorenzo Bini Smaghi calls for quantitative easing to boost eurozone economy

• Moody's says that the outlook on the US government's AAA credit rating remains negative

• French Q3 GDP unexpectedly revised down to 0.3% q/q from 0.4% q/q

• UK net mortgage lending hits record low

Market reaction

The dollar came under pressure on Friday as better than expected US economic data supported risk appetite and weighed on haven demand for the currency.

The Australian dollar and other risk-correlated currencies advanced as equities traded on a firm footing after a fall in US jobless claims and rise in consumer sentiment on Thursday.

That said, AUDUSD remained in its recent range, although EURAUD traded to a fresh record low amid holiday-thinned markets.

NZDUSD suffered an early sell-off after two earthquakes struck the city of Christchurch, just 10 months after a tremor caused substantial damage to the city. But the kiwi regained some poise to trade higher later in the session as it emerged that only minor damage had been incurred.

Meanwhile, EURUSD found support even as figures from the European Central Bank showed banks had deposited a record amount in its overnight facility – suggesting ongoing distrust in the inter-bank lending market – and an ECB council member called for quantitative easing in the eurozone .

Elsewhere, GBPUSD stayed within its recent range, while USDJPY was little moved around ¥78, with a holiday in Tokyo limiting trading activity.

Flows

A relatively favourable risk-backdrop helped EURUSD reach a session high of $1.3094 in Asia although trader reports of offers at $1.31 helped cap the move. EURUSD is expected to be contained well within a $1.30 – $1.31 range with exporters and Asian accounts buying on dips and leveraged accounts which are still operating, happy to sell rallies.

NZDUSD rebounded from a knee-jerk sell-off after the earthquake. NZDUSD hit a session low of $0.7720 but soon recovered from the fall, as short-term account buying took advantage of the discount level on the high-beta currency. NZDUSD is trading firmly around $0.7740, though now with muted interest either way.

AUDUSD traded constructively in Asia as macro names were buyers on the crosses. AUDUSD climbed $1.0129 to $1.0180, but retraced around half of the move as offers in London faded the rally back down to the $1.0155 region.

GBPUSD found early support, looking to test $1.5700 but weaker UK data brought out some selling bringing cable down to session lows in the $1.5670 region.

EURCHF recovered from earlier moves down to Sfr1.22 with Asian names reportedly buying on dollar dips helping EURCHF back up the Sfr1.2220 region.

Option expiries of note for Friday December 23 are EURUSD at $1.31; USDJPY at 77.95 and 78.00; USDCAD at $1.02.

Positioning

Year end flows into dollars have been driven by traditional position unwinding rather than large repatriation flows.

Morgan Stanley’s positioning tracker index, which uses six indicators to estimate positioning in G10 currencies, shows the largest long positions to be in JPY and USD since Monday December 19. The largest short positions are in CAD, NZD, and NOK.

The largest move intra-week was in GBP, where the MS positioning estimates indicate investors moderately increased GBP shorts.


 Morgan Stanley Positioning Tracker scores

 
 Source: Morgan Stanley

Options FX options markets largely unchanged as interest dropped sharply in thin year-end liquidity.

EURUSD 1-week and 1-month vols traded at 9.37 and 12.76 respectively, fractionally higher over Thursday’s levels. EURUSD 3-month vol was 0.2 higher, now trading at 14.05.

1-month risk reversals have come off further, trading at -2.61, their lowest level since the end of July.

USDJPY 1-month implied vol traded at 7.38, close to the lowest level since July 07.

What to look for

The dip in the New Zealand dollar following news of an earthquake in Christchurch was an understandable knee-jerk reaction.

However, natural disasters are not necessarily negative for a currency. Indeed, the reaction of the Chilean peso and the yen after recent earthquakes suggests the reverse is true.

“It is not unusual for investors to sell a currency on a natural disaster, but this often proves the wrong response as any short-term impact on the real economy tends to be more than offset by a later rebuilding push,” says Todd Elmer at Citi.

Spot, 6am, EST

 
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