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Foreign Exchange

Asian reserve managers halt EURUSD rally

EURUSD failed to sustain its recent rally as dollar demand from Asian central banks and caution ahead of a decision on private sector involvement in Greek rescue plans undermined the single currency.

Headlines • Greek finance minister reports “good progress” at talks with private sector bondholders

• Asian stocks rally on improved eurozone sentiment and positive US data and corporate earnings

• HSBC China manufacturing purchasing managers’ index rises to 48.8 in January

• EU governments set tougher rules on budget deficits in draft of planned fiscal treaty – Bloomberg

• UK retail sales rise 0.6% in December, recovering from 0.5% drop in November

Market reaction and flows


USD

Talk of Asian reserve-management demand for dollars has,  helped dampen the short-squeeze move higher in risk currencies. Traders say there is also evidence of defensive dollar-buying creeping in ahead of talks on private sector involvement in Greek bailout plans and as pressure on Portuguese bonds continued.

EUR

Traders at one top-five bank said the flow on Friday in EURUSD was low volume and was largely profit taking from accounts that rode the short squeeze higher and now exited long euro exposure.

Traders say EURJPY support around 99.70 helped support EURUSD for a short period, but once filled, EURUSD losses accelerated down towards $1.29 as tactical longs exited.

There are some reports of real money continuing to buy of EUR on dips, suggesting some euro bears are reducing exposure after this week’s encouraging bond-market auctions, but overall flows suggest EURUSD may struggle to extend its gains on Friday above $1.30 for now.

EUR bears are advised to proceed with caution given that any deal regarding Greece’s debt restructuring, even a modest one, would inject a welcome degree of certainty in the eurozone and take out some of the short-term risk premium. That could add further fuel to a rally that appears to have petered out, and could send EURUSD through $1.30 and as high as $1.32, given that a large portion of the market still remains heavily short, according to Adam Cole, head of FX strategy at RBC.

JPY

EURJPY extended gains and breached Y100, though was forced back down to Y99.70 after strong rounds of hedging interest from Japanese exporters filled in the US, which also caused USDJPY to fall 10 to around Y77.15. Though USDJPY has failed to manage two consecutive days above Y77 since the start of the year, the overall risk-backdrop seems more supportive for USDJPY and yen crosses.

However, the recent weakness of the yen has started to see a pick up in yen demand from Japanese exporter hedging, as indicated by a rise in corporate flow from Bank of Tokyo-Mitsubishi, which may cap weakness in the yen.

GBP

GBPUSD ran up to $1.5450 after relatively strong UK retail sales and an interview with MPC member Ben Broadbent, which indicated no pre-commitment from the Bank of England to future quantitative easing that could have reduced strong expectations of more monetary stimulus next month.

CHF

EURCHF fell below SFr1.2075 after it ran into fund supply from 1.2090 in early Europe. As dollar flows helped USDCHF rebound 0.9300 to 0.9360, and helped cap the move lower in EURCHF, the weight of short-term interest seems to be more skewed to a downside test.

UBS have said, while they believe the floor will remain in place, the SNB rhetoric and recent turmoil surrounding the former chairman have increased the appetite for a test. UBS thus recommend the pair as a sell at SFr1.21 but a buy at SFr1.20.

Options

EURUSD vols continue to soften, with one-month vols trading 11.45 versus 12.20 on Monday, and three-month 12.25 versus 12.65.

With this week’s risk rally indicating that stresses in the market are easing, and given the potential for the euro to break higher (RBC says there is potential for a spike to 1.32 on the resolution regarding Greece), some traders believe this could be a good time to reassess the idea of buying protection.

One trader says he is taking advantage of the short gamma market position in EURJPY above 100 by owning EURJPY one-month calls and call spreads. This cross has the shortest gamma position in the market, so presents the most upside in a positioning sense, should there be a Greek resolution.

On risk reversals, EURUSD and AUDUSD riskies are near six-month lows for puts.

There is renewed interest in EURCHF downside, another trader says. One typical structure has been the selling of 1.20 strikes and buying of 1.17 strikes, and below in ratio spreads. The trader says this hasn’t been well received by market makers because pricing downside on EURCHF has proved to be more of an art than a science.

Positioning

Morgan Stanley’s FX Positioning Tracker, which aggregates data from six separate positioning indicators, shows investors have added to their bets against the euro, as the single currency has rallied this week.

The EUR has shifted into “extreme short territory”, according to Morgan Stanley, hitting levels last seen in October, thanks to extremely heavy selling on the Tokyo Financial Exchange.

The largest short position is in the euro, while the largest long positions are in the USD and JPY.

The other notable shift was in the GBP, which moved from short to neutral as Morgan Stanley’s proxy for hedge fund activity showed a pull back from extreme short positions in the currency.


 Morgan Stanley FX Positioning Tracker

 
 Source: Morgan Stanley


What to look for: MXN to outperform

The Mexican peso is the most undervalued currency in the world, according to real effective exchange rate analysis from the Bank for International Settlements.

Credit Suisse believes the currency, which unlike other emerging market currencies has not seen a marked recovery from the losses incurred during the financial crisis, stands out in terms of its potential scope for appreciation this year.

Credit Suisse says this reflects Mexico’s competitive advantage and its potential to benefit from a rebound in the US. The bank has moved its three-month target in USDMXN to 13.50 pesos and its 12-month target to 12.75 pesos.

“The outlook for outperformance reflects Mexico’s high gearing to US activity and the substantial gains in exchange rate competitiveness Mexico has accrued over the crisis period,” analysts say.


 Real effective exchange rates - peso has gained competitive advantage

 
 Source: Credit Suisse, Haver Analytics

Spot, 6.45 EST

 

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