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Foreign Exchange

Dollar in demand as sovereign debt fears heighten

The dollar and the yen found support as concerns over sovereign debt continued, while the euro received little respite from the election of a pro-reform government in Spain.

Headlines • Mariano Rajoy leads centre-right Spanish People’s Party to biggest parliamentary majority in Spanish election for more than 20 years

• Moody’s: A rise in interest rates on French government debt and weaker growth prospects could be negative for the outlook on France's credit rating

• US lawmakers “unlikely” to agree on $1.2 trillion in budget cuts by Monday evening

• Bank of Japan minutes (October 27) show a “few members” suggesting that 2-year JGB buys would be “effective” for FX, stronger yen “worsens” Japanese economy

• Japanese exports falling by a larger than expected -4.8% in October on a real basis according to the BoJ

• Chinese Vice-Premier Wang Qishan said “Global economic conditions remain grim, and ensuring economic recovery is the overriding priority”

• Nikkei Daily said Japan’s Kokusai Asset Management had sold the entire holdings of Spanish and Belgium debt that were part of its flagship fund

• British Retail Consortium reports sharp drop in footfall in UK shops in October; UK house prices register biggest monthly fall since November 2007

Market reaction

EUR failed to find support after the Spanish elections over the weekend as the prospect of economic reforms in Madrid did little to ease concerns over sovereign debt in the eurozone.

EURUSD again tested its recent lows around $1.3440 as Spanish government bonds gave up initial gains. The spread of the yields on Spanish bonds over German bunds rose above 450 basis points, the level considered to be where clearing houses raise margin requirements for trading eurozone government debt.

Sentiment towards the single currency soured as rating agency Moody’s warned over French sovereign debt.

Fragile investor confidence in sovereign debt was dealt another blow by reports that the US Super Committee charged with tackling the country’s budget deficit had failed to reach an agreement on spending cuts.

Weakness in global equities fed haven demand for the USD and JPY, with the Japanese currency rising to levels last seen before Tokyo’s intervention last month.

Commodity-linked currencies suffered as investors liquidated risky positions. AUD traded down to a six-week low just below $0.99, while CAD and NZD also lost ground.

GBPUSD also came under pressure, trading down below $1.57 as weak UK economic data fed concerns over the health of the UK economy.

Spot, 7.00 AM New York



EURUSD drifted lower, through 1.3450 after good selling interest from a Middle Eastern account and macro hedge funds in the early London session. Banks say several profit-take orders and support linked to outstanding option barriers at 1.34 will help cap significant moves lower as well as strong demand seen from European corporates.

A top-tier bank has reported decent buying interest in several euro crosses, as growth fears start to weigh on the cyclical currencies.

AUDUSD steadily falling as selling from momentum accounts and leveraged funds picked up around the 0.9960-70 level. Stops triggered around 0.9930 to 0.9900 accelerated the move lower through 0.99, although decent corporate demand has slowed the descent further.

Banks have also seen real money selling of GBPUSD in London after weak economic data overnight emphasized the negative UK economic situation.


CFTC data showed the largest weekly change in euro positioning on the International Money Market in nearly 2 months as investors from the leveraged funds category increased their net short exposure by over 40%.

Investors increased long USD exposure by $3.89 billion, buying the US dollar against every currency except the Japanese yen and Mexican peso. Aggregate long USD positioning now stands at close to $10 billion on 15 November.

The report shows the strongest buying interest was in Japanese yen as investors increased net long JPY exposure by 5,600 contracts, leaving the market net long 33,680 contracts.


Option vols continue to drift lower Monday following last week's failure of the EURUSD to break below $1.3440. 1-week EUR/USD vol traded as low at 13.6 (mid level) and is now slightly higher, while its average level since the start of September has been 15.7. The 1W realised vol has been even lower, as it is under 10 on a daily basis, traders say. The euro drop towards 1.3440 is failing to drive longer-dated vols higher, as European bond yields are not starting the week under significant pressure.

Some traders expect that Thanksgiving should lead to lower liquidity this week, and with spot contained vols may have more room to come off. Though, market remains jittery, and therefore downside in outright vols should remain limited.

In Japan, Societe Generale notes USD/JPY 1-week vols are below 8 for the first time since early June. Where there is no realised vol at all: on a daily basis (close-to-close spot levels), it is below 2. For reference, implied vols levels at 8 and 13 require daily spot moves of 0.42% and 0.68% respectively to make a long gamma position profitable given the time decay. Option strategists at SG believe that spot moves of such amplitude are extremely likely during illiquid trading sessions. Sparse sizable orders have a much greater price impact than when there is more liquidity because the market has more difficulty absorbing them. Therefore, holidays cannot secure quiet trading sessions.

What to look for

The spread on Spanish bond yields over German bunds is now over the critical 450 basis points, a level which LCH Clearnet considers a benchmark for raising its collateral requirements.

Two weeks ago when LCH raised margin requirements on Italian government securities, 10-year benchmark yields soared through 7% and the euro plummeted, losing two cents against the dollar.

The action in the Spanish bond market this morning reflects the fact that even though Spain’s electorate has punished the outgoing socialist government for its economic stewardship, the conservative government faces a tough challenge with unemployment at over 20 per cent and the economy stagnating.

With the new Spanish government likely to enjoy the shortest of honeymoons, the euro looks vulnerable.

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