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Foreign Exchange

Aussie dollar dips below parity but euro remains resilient

The Australian dollar dropped below parity against the dollar for the first time in one month as worries over the effects of the escalating crisis in the eurozone pushed investors away from risky assets, but the euro once again failed to break lower.

Headlines • ECB president Mario Draghi presses eurozone leaders to kickstart the EFSF rescue fund and warns of massive economic and social costs if ECB credibility was put at stake

• Reports in German press suggest ECB Governing Council members agree on EUR20 billion weekly upper-limit for sovereign debt purchases

• ECB’s Makuch says central bank will “do what is needed” in debt crisis

• Bank of England’s Weale sees “strong case” for more UK stimulus in February.

• Merkel rejects calls to deploy ECB as guarantor of euro debt: “If politicians believe the ECB can solve the problem of the euro’s weakness, then they’re trying to convince themselves of something that won’t happen”

• The FT reported that The UK’s top four banks cut interbank loan volumes to eurozone periphery by 24% in Q3

• Italian PM, Mario Monti, wins vote of confidence on new government’s programme

• China’s Market News International Business Sentiment Survey falls to 55.5 in November from 58.5 in October.

• Chinese equities lost 2% overnight, taking commodities and AUD with it

• Taiwan’s China Steel Corp asked global miners BHP Billiton, Rio Tinto and Vale to suspend or reduce deliveries of iron and coking coal because of slowing output requirement

Market reaction

The AUD bore the brunt of market nervousness early on Friday, with sharp falls in Asian equities pulling other risk proxies such as the CAD and NZD lower.

AUD traded down to a low of $0.9965, it weakest level since October 12, with reports that a Taiwan steel producer was suspending Australian commodity imports adding to the negative sentiment surrounding the currency.

But a familiar pattern re-emerged as London came into the market, with the USD giving back its gains from the Asian session.

EURUSD remained relatively stable, even as the continuing worries over the eurozone’s sovereign debt crisis showed little sign of abating.

The EUR once again failed to break down through the $1.3440 level against the dollar, with some putting the currency’s resilience to reports of further buying of European government bonds by the European Central Bank. The debate rages within the eurozone, however, as to whether the ECB should be a lender of last resort to debt-stricken nations.

EURUSD pulled back sharply as the London session got underway, rising above $1.35 as short term sellers lost patience and squared positions.

The JPY found support from ongoing market nervousness, trading up to Y76.62 against the dollar, its strongest level since the Bank of Japan intervened on October 31.

Spot, 7.00 AM New York

EUR: Current: 1.3520 Open: 1.3495 Support: 1.3410 Resistance: 1.3565

GBP: Current: 1.5850 Open: 1.5775 Support: 1.5700 Resistance: 1.5910

EURGBP: Current: 0.8550 Open: 0.8550 Support: 0.8520 Resistance: 0.8580

CHF: Current: 0.9140 Open: 0.9190 Support: 0.9080 Resistance: 0.9275

EURCHF: Current: 1.2350 Open: 1.2410 Support: 1.2320 Resistance: 1.2475

JPY: Current: 76.70 Open: 76.87 Support: 76.60 Resistance: 77.30

EURJPY: Current: 103.70 Open: 103.75 Support: 103.30 Resistance: 105.00

AUD: Current: 1.0025 Open: 0.9978 Support: 0.9925 Resistance: 1.0100

NZD: Current: 0.7590 Open: 0.7568 Support: 0.7500 Resistance: 0.7750

CAD: Current: 1.0260 Open: 1.0285 Support: 1.0200 Resistance: 1.0320

Flows

Emerging pattern, that risk-off moves in Asia on little or no news tends to correct itself in the early European session, with EURUSD subject to short squeezes. Dollar saw a slight weakening across the board.

EURUSD. Volumes slightly down on normal. Early morning flow at a tier one bank was seeing bias towards euro downside, with the skew at 52% EURUSD selling. Soon began to see strong buying as the shorts ran out of patience with EURUSD moving aggressively higher through $1.3540.

USDJPY. Traders say stops building below Y76.50, with offers creeping slowly lower. Yen short end rates came in higher which helped guide the USDJPY to post intervention lows of Y76.62.

EURJPY seems to have found a base in the short term in the upper Y103 range.

AUDUSD. Bearish sentiment continued to build. Morning flow excessively skewed in favour of selling (59%) at top tier bank as AUDUSD tipped below parity. AUDUSD retraced some of the move lower but continues to look vulnerable, hovering 10 – 20 pips above $1.00.

EURHUF: Sharp move higher as several large long positions were re-established after being unwound last night on the back of unsubstantiated rumours that the IMF was coming in.

Positioning

Dollar long still close to the highest levels seen since 2008 according to Deutsche Bank’s analytics while the core euro short is also close to record levels and has remained very stable.

Deutsche’s metrics show a persistent and sizeable long in China, whereas the rest of EM is more or less flat.

“With little scope for investors to add to euro short for EURUSD to go down from these levels we need to see the market losing faith in the Chinese story,” said Henrik Gullberg, FX strategist at Deutsche Bank.

“For EURUSD to really capitulate there needs to be an unwinding of the USDCNY short but so far there are no signs of that happening.”

The Australian dollar short, which we reported on Thursday was at 12 month highs still remains sizeable but has come off a bit, following a short squeeze earlier as dollar longs saw a moderate unwinding.

Swaps

The New York Federal Reserve revealed that the ECB had utilised $500 million of the Fed’s dollar swap facility for seven days and a further $395 million in an 84-day swap in a further sign of worsening dollar liquidity conditions.

The basis swaps market also shows increased demand for dollars. The yield lenders of euros are willing to forgo in exchange for dollars reached 136 basis points for a 3-month swap, which is the largest amount since November 2008 at the height of the dollar liquidity squeeze after the collapse of Lehman Brothers.

Options

Vols were little changed on Friday for both G10 and EM pairs. Range trading is going further in EURUSD, and the longer it lasts the closer the break gets. That is why the EURUSD implied vol curve is not shifting lower, despite the falling realised volatility, which has been below 10 throughout this week, says Societe Generale.

A lot of strikes around $1.35 in EURUSD expired on Thursday in the option market, and there are still some on Friday. That is surely not the only factor explaining why the euro is stuck around this level, because range trading prevails in other crosses.

But the cleaning out of these strikes will surely help the spot to break free. Given the configuration of front-end vols, the odds are rather for an end-of-week consolidation. There is room for short covering, traders say.

What to look for

The euro continues to show resilience in the face of the eurozone debt crisis, but price action in the government bond market suggests that might be about to end.

Thus far rising peripheral eurozone government bond yields have been matched by falling yields in German bund yields as managers reallocate funds within the region. The failure of bund yields to fall in recent sessions suggests that managers might be abandoning the region entirely.

Reports in the UK press suggest there is evidence that Asian investors and central banks have begun to sell German bonds and pull out of the eurozone altogether for the first time since the debt crisis began.

If that is the case, EURUSD is set to lose a major source of support as the regular bids from Asian central banks and sovereign wealth funds disappear from the market.

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