Headlines • Strong demand at Spanish bond auction as Madrid sells €2.5 billion of four-year notes at yield of 3.748%, down from 4.871% previously
• Italy sells €8.5 billion of one-year bills at 2.735%, down from 5.952% at previous sale
• China’s December CPI inflation came in at 4.1% versus consensus calls for 4% reading, down from 4.2% in November
• UK industrial production declined at an annual rate 3.1% in November, worse than the expected 2.2% fall
• Japan’s current account surplus falls 85.5% y/y in November – bigger than forecast 74.7% drop
Market reaction and flows
USD
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The dollar came under broad pressure as successful debt auctions in Italy and Spain lifted investor sentiment and weighed on haven demand for the US currency. That said, figures continue to point to a recovery in the US, with the Federal Reserve’s Beige Book showing growth in most regions and retail sales data later in the session likely to underline the relative outperformance of the country’s economy. EUR
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EURUSD found support after the Spanish and Italian debt sales indicated that the moves from the ECB last month to lower interest rates and inject liquidity into the financial system were starting to have an effect, although worries over the eurozone debt crisis still remained evident. After dropping down towards a 16-month low below $1.2700 on Wednesday, bids from a supra-national account and sovereign demand helped EURUSD take out stops above the $1.2750 level.
Caution remained, however, ahead of the ECB’s policy meeting late in the session, with traders noting large offers from $1.2770 up to the $1.2800 level.
GBP
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Sterling suffered as gloomy news from UK retailers over the festive period and a larger-than-expected drop in industrial production raised expectations that the Bank of England would have to take further measures to stimulate the economy. No further action was expected at Thursday’s Bank of England meeting, however, given that the central bank was widely expected to wait for the current £75 billion of additional quantitative easing purchases to conclude at the end of the month before announcing any further action.
GBPUSD broke down through $1.5300, with many looking for a test of the October low at $1.5270, while EURGBP moved up to the £0.8320 level, although its progress was hampered as traders noted large selling from a UK clearer and a US bank on any rallies.
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CHF EURCHF tested its lows around SFr1.2100 despite the improvement in risk appetite as the Swiss National Bank’s commitment to its SFr1.20 floor continued to come under scrutiny after the resignation of chairman Philipp Hildebrand earlier this week. The SFr1.21 level remains key, with talk of large option barriers and bid from the SNB under the figure.
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AUD Improved risk appetite helped pull AUDUSD higher, but selling interest from an Asian central bank kept its gains in check. Traders expect further gains to be hard fought as investors look to protect barrier options in AUDUSD at the $1.0400 level.
HUF
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The Hungarian forint staged a mini relief rally with EURHUF hitting Ft305 after the encouraging eurozone debt sales that reduced some of the risk-premia in the beleaguered currency, as with other Eastern European currencies. The forint has also benefited from anticipation of potential positive news flow on Thursday afternoon regarding Hungary’s fiscal situation after the talks between Hungarian officials and IMF.
Positioning
Looking at Barclays Capital, proprietary flow data since the start of the year shows USD buying has been roughly flat, though there has been continued dollar buying from the leveraged community.
There has been consistent selling in EUR, particularly from the leveraged community, a theme also echoed by Citigroup’s flows.
Citi’s Pain index on hedge-fund positioning dropped sharply after reaching a 2011 high a week ago. Whilst still slightly above the 2011 low, the rise in the negative correlation between EUR and hedge-fund returns suggests there is an increasing concentration of short positions.
In Sterling, Barclays saw overall net buying, though this is likely to have been through selling EURGBP rather than buying in GBPUSD, in which investors have preferred to be short, says Sara Yates, FX strategist at the bank.
In AUD and NZD, flows since the start of 2012 have been net short, though the gap is closing as strong buying of the commodity currencies this week is counterbalancing the selling seen in the first week of January.
Options
EURUSD implied volatility has remained contained ahead of the ECB meeting on Thursday, with the market expecting no significant change in policy. One-month at the money vols are trading under 12, and one-year vols have moved back under 14.
The short end of the vol curve has remained under pressure with one-week and one-month losing close to one vol this week, and there is heavy congestion of option barriers in the 1.2660-1.25 region with expiries shorter than one week.
“A fall in spot in this area would trigger buy-backs of vanilla hedges because option desks have a long gamma risk,” says Société Générale’s FX derivatives strategist Olivier Korber. “As a consequence, we would have a sharp pick-up in front-end vols and risk reversals.”
The sell-off in AUD volatility this week seemingly came to a halt on Thursday as the market treaded with increased caution. Société Générale considers NZD vols to be particularly cheap at this time, with one-month trading 0.4 under AUD one-month vol and NZD three-month risk reversal at -2.9, less than the -3.2 in AUD.
“The kiwi is usually more volatile in such periods, so we like buying NZD vol,” says Korber.
| EURUSD vol monitor |
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| Source: Soc Gen |
What to look for: GBP under pressure Sterling is likely to remain under pressure as updates from retailers confirm that UK consumers remained extremely hesitant over the Christmas period.
Shares in Tesco, the UK’s largest retailer, slumped more than 10 % as like-for-like sales dropped by 2.3% in the six weeks to January 7, with the company warning that it expected minimal profit growth in the next financial year.
Michael Derks, chief strategist at FxPro, says the unsurprising revelation that festive season sales were very soft was not doing the pound any favours, with GBPUSD falling below $1.53 and EURGBP underperforming.
“With the Chancellor admitting to MPs yesterday that an extra £10 billion may need to be provided to the IMF despite the UK’s desperate fiscal plight, it is little wonder that the currency is under pressure,” he adds.
Spot, 6.45am, EST
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