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Traders caught in euro bear trap

Crisis? What crisis? The euro continued to defy gravity on Tuesday as Italy saw good demand at a sovereign bond auction while sterling found support ahead of what was expected to be a dire UK budget statement

Headlines • Italy completes E7.5 billion bond auction, sold three-year bonds at a gross yield of 7.89 per cent and 10-year bonds at a cost of 7.56 per cent

• S&P could change its outlook on France to negative within 10 days, according to La Tribune

• Moody’s placed the subordinated debt of 87 European banks on downward review

• Japan’s Nomura has cut its exposure to eurozone periphery debt from $3.55 billion at the end of September to $884 million

• Fitch maintained the US’ AAA rating, but changed the outlook from stable to negative

• UK chancellor Osborne will be forced to admit UK’s structural deficit has increased by £30 billion in Autumn budget statement, Financial Times

• Foreigners increased UK gilt purchases in October to £12.5 billion from £9.2 billion in September

• Swedish GDP much stronger than expected in Q3, gaining 1.6% q/q and 4.6% y/y

Market reaction

Another risk-on day saw EURUSD take its lead from global stock markets, pulling sharply away from its lows around $1.3290 as Asian equities surged higher and testing $1.3370 early in the session.

EURUSD was given an extra push to a one-week high above $1.34 as good demand at an Italian government bond auction boosted risk appetite and lifted European stocks , allbeit with investors choosing to ignore the fact that Rome was forced to pay record rates to secure the funding.

The euro continued to defy gravity even as Moody’s warned over European bank debt and speculation heightened that France could be on the receiving end of a downgrade.

Some put the euro’s resilience down to hopes that a meeting of eurozone finance ministers later in the session would finally release an E8 billion tranche of aid for Greece and sign off on the technical details of the leveraging of the EFSF, the region’s rescue fund.

There was also speculation that with the market short of the euro, investors could be caught in a bear trap if global actors such as the IMF, China or the US were to ride aggressively to the eurozone’s rescue.

Other risk sensitive currencies also pulled higher as equities rallied, with the AUD breaking up through parity against the dollar and the NZD and CAD finding support.

GBPUSD was also in demand, rising above $1.56 ahead of the UK autumn budget statement with many reasoning that the bad news over growth had already been priced into sterling given the stream of leaks from the British government in recent days.

JPY came under pressure, reflecting increased concerns over Japanese government debt, with USDJPY hitting highs around Y78.20 and the JPY hitting its weakest level on a trade-weighted basis since October’s intervention from the Bank of Japan.

SEK found support after Swedish third quarter growth came in above forecast.

Elsewhere, EURHUF held steady around 309.50, but investors remained wary that the National Bank of Hungary might raise interest rates at its meeting later in the session in a bid to prop up the forint.


Month-end dollar selling a big factor in today’s flow.

Traders say the EUR upswing following the reasonably successful Italian bond auction has come largely from short covering rather than long position building.

Month-end recycling of Asia FX reserves has also helped EURUSD push back through $1.34.

GBPUSD built on early demand from Asian sovereigns and saw buying interest largely on the back of the EURUSD rally which saw the pair move above $1.5600. This morning’s Bank of England data indicated foreigners extended demand for gilts in October added to the supportive backdrop for sterling. In EURGBP, corporate bids are tipped from the £0.8550-60 area.

The run higher in USDJPY came after persistent real money and macro funds interest on Monday, which encouraged large Japanese bank interest that took out buy stops over Y78.00. Japanese banks were said to be active via the crosses, with buyers in AUDJPY around Y78.00 while EURJPY was boosted by another Asian fund.

USDJPY since pulled back to the 77.60 area, which traders say is down to an environment of broad dollar weakness rather than notable yen bullishness.

Strong buying interest from leverage accounts and an encouraged equity market tone helped AUDUSD stay firm above parity for the first time in well over a week.


The CFTC’s latest IMM report shows investors continue to increase USD exposure with the dollar bought against every currency except the JPY, for the second week running.

Investors increased their Japanese yen net exposure by 9,500 contracts, a 28% increase bringing the total net long to 43,180 contracts, the largest non-USD long currency position.

Aggregate long USD positioning now stands at $12.64 billion.

Euro and Commodity bloc shorts increase

The largest net short is still in EUR, with investors net selling 8,921 contracts last week, bringing the total net short to 85,068 contracts.

In the commodity currencies, the net longs in AUD and NZD each fell by more than 25% bringing the total net long in AUD and NZD to 17,960 and 7916 respectively. Meanwhile, the CAD net short rose by 22% to 22,144 contracts.

By far the strongest selling interest last week was in MXN, as investors more than doubled their net short exposure. The market is now net short 31,58k MXN contracts, the largest net short seen on the IMM since June 2004.


The three-month EURUSD basis swap moved wider from Monday’s European close of -148, to -157 at 11:30 am London time. Despite the risk-on theme today, weaker correlation continues, with flow dominating, over sentiment. Another notable factor is that one-month forwards date now over the year-end turn, which has influenced the wider levels.


Interest has been concentrated in the short dates which traders say feels like just cleaning up of positions before the year end, rather than looking for a position to take into the new year. Another trader says the market caught a bit off guard by the size of the rally in spot, but as is typical with “risk-on” days, there isn’t typically a huge amount of interest in options.

With a second successive “risk-on” day, traders also say AUD gamma has gone fairly well bid as the result of the market being long the short dated risk reversal and so as a result has been busy buying back topside strikes.

In terms of gamma positioning, market makers seem to be very short AUD/JPY gamma, but long USD/JPY gamma simultaneously, and traders also note a similar short gamma positioning on Euro crosses. This comes at what is potentially the last week of the year with significant data in the pipeline, given the US NFP release on Friday and the central bank meetings in Europe. Another trader notes that JPY vols remain well bid, with interest to buy longer dated JPY puts.

Hungarian forint vols are trading at their highest since 2009, as the EUR/HUF ATM curve is marked from 17.5 on the 1W/1M to 16 on the 1Y. Spot's acceleration to 315 stimulated the demand for hedges. Spot easing off in the European session however, reducing the bid tone for vols ahead of the Bank of Hungary rate decision due at 8 am New York time.

What to look for

The yen is slowly losing its allure.

Despite the eurozone debt crisis intensifying in the second half of November, USDJPY steadily climbed back to the Y78 handle suggesting the yen may be losing some of its safe haven status and is becoming less attractive at current overvalued levels.

The recent warnings from the IMF, OECD and Standard & Poor's over the risks to the economy of a spike higher in Japanese government bond yields have once again brought the sustainability of Japan’s government finances into question.

Interestingly, the near-term rise in yen bearishness is evident in the options market where the 1-month USDJPY risk reversal have become positive for the first time in more than 7 years, implying demand in the options market is increasing for USDJPY upside protection.

However, Bank of Tokyo Mitsubishi UFJ strategists are unconvinced that a significant yen-negative sell off in the Japanese government bond market is imminent. Supply and demand dynamics are largely dictated domestically, and domestic demand is improving as deflation persists and household saving rates rise.

With this in mind, the recent yen weakness seems unlikely to prove sustainable with the current level of yen overvaluation far from overly burdensome and global risk aversion still elevated.

Spot, 6.45am EST


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