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Foreign Exchange

French downgrade speculation drags euro lower

The euro lurched lower on Thursday as rumours of a downgrade of French sovereign debt undermined the single currency, but warnings of further action from Switzerland capped strength in the franc.

Headlines • Fitch warns “high and rising” federal and general government debt burden not consistent with the US retaining its AAA status

• UK final GDP expanded by 0.6% in third quarter, stronger than previous 0.5% estimate

• Three sources with “direct knowledge of the matter” tell Reuters that more than a dozen Italian banks, took a total of €116 billion at Wednesday’s 3-year LTRO

• Standard & Poor’s cuts Hungary’s long-term credit rating by a notch to BB+

• Foreign investors purchased a net ¥2.66 trillion of Japanese money market instruments in the week to December 16, the second largest weekly amount on record.

Market reaction

EURUSD plunged lower through $1.3100 as speculation resurfaced over a downgrade of French sovereign debt.

The move followed a sharp drop in the previous session after the initial optimism sparked by a large uptake from the European Central Bank’s 3-year LTRO fizzled out.

While, the fact that over 500 banks tapped the ECB for funding reassured investors that it was unlikely a eurozone bank would fail for liquidity reasons, there was less optimism that the funds would be put to work in the sovereign debt market rather kept on banks’ balance sheets.

EURGBP also lost ground, testing support around £0.8300, while EURJPY dropped below Y102.

EURCHF remained supported above SFr1.2200, however, after Swiss officials stepped up the rhetoric regarding the strength of the franc. Eveline Widmer-Sclumpf, Swiss finance minister, said the government and the Swiss National Bank was considering introducing capital controls and negative interest rates to combat strength in the currency.

Meanwhile, the dollar found support elsewhere, with GBPUSD dropping through $1.5700 despite an upward revision to UK growth, while AUDUSD traded on heavy footing.


EURUSD was unable to sustain the move above $1.31 after Middle Eastern names were reportedly buyers as London opened and took out several stops above the figure. The pair moved as highs as $1.3122 but soon encountered selling as rumours of French downgrades and a lower 3m Euribor fix caused EURUSD to lose 50 pips in thin trading conditions. EURUSD then settled and flat lined around $1.3050.

A large amount of EURUSD option are tipped for expiry on Thursday with strike congestion between $1.30 and $1.31 which traders say should keep EURUSD relatively contained.

EURCHF held firm around SFr1.22 and rallied 20-30 pips after good demand out of Switzerland before running out of steam around SFr1.2230. The latent risk of SNB action has resulted in continued choppy two-way flows ahead of very good bids layered down to the SFr1.2120 level where the SNB is tipped to be a strong buyer in defence of the SFr1.21 figure.

GBPUSD held relatively firm as Middle Eastern interest lifted cable above $1.57, though this was soon countered by dollar flows. Demand for sterling helped EURGBP test the £0.8300 mark again though the move lower met a floor above the figure with bids at £0.8310 moving the pair back to £0.8330.

AUD steadied around $1.010 with relatively muted interested while EURAUD hovered close to record lows around A$1.2880.

USDJPY gained roughly 30 pips in Asia following yen selling from importers. USDJPY was then anchored during the London session by option expiries at Y78.00 for the 3.00pm GMT NY cut.


EURUSD implied volatility moved slightly higher although limited activity has kept option vols in a very tight range this week after last week’s heavy sell-off.

1-week ATM vol barely moved, trading at firmly around 9.9 having plunged down from 15 last week. 1-month ATM implied vol trading at 12.92, up 0.2 from Wednesday, while 3-month ATM vol trading at 14.38, up 0.1.

What to look for

Hot money continues to flow into Japan as investors look for a haven from the slowdown in global growth.

Figures on Wednesday showed foreign investors bought ¥2.66 trillion of Japanese short-term money market instruments in the week to December 16. That was the second largest weekly total on record and brought the value of inflows in 2011 to ¥16 trillion.

That is roughly equivalent to the amount that Tokyo has spent in intervention in a bid to keep a lid on gains in the yen and protect its exporters. Clearly, if the flow of hot money seeking sanctuary in the yen continues, the Japanese government will be forced to step in to the currency markets once again.

Spot, 7am, EST

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