Commodity Currencies Surge on Coordinated Central Bank Intervention

Fundamental Headlines

• ADP Says U.S. Companies Added 206,000 Workers – Bloomberg

• German Jobless Slip as Companies Defy Crisis – Bloomberg

• China Cuts Bank Reserves in Policy Shift to Lift Economy – Reuters

• Central Banks Take Coordinated Action – WSJ

• Euro-zone Falls Short on Fund – WSJ

European Session Summary

Markets have been screaming for help. For months, it appeared that policymakers were tone deaf, and were just now coming around to the realization that their prescribed measures have fallen short across the board. After another Euro-zone summit broke last night, with no developments suggesting that the European Financial Stability Facility would be broad enough to save the Euro, and China cut its key rate for the first time since the financial crisis, it appeared markets would be pricing in a “risk-off” day. Indeed, by the end of trading in Asia, the U.S. Dollar was among the top performers while the higher yielding currencies led declines. The landscape was altered dramatically ahead of trading in New York, however.

Central banks from the world’s most developed economies, headed by the Federal Reserve, announced that coordinated action had been taken to increase liquidity in global financial markets. The Federal Reserve cut the rate at which its liquidity swap arrangements with other central banks are conducted at. Essentially, these programs allow central banks to exchange their currency for U.S. Dollars (thus diminishing the value of the Greenback) and then lend said funds to commercial banks in their respective countries.

EUR/USD 1-minute Chart: November 30, 2011

Charts created using Strategy Trader– Prepared by Christopher Vecchio

The development has been bullish for risk-appetite – as expected – but there have been some odd intricacies about the price action this morning. The commodity currency block, collectively yielding the highest among the major currencies, soared on the news: additional liquidity in the financial system encourages risk taking. The Australian Dollar and the New Zealand Dollar were up over 2 percent each, at the time this report was written.

The Euro, on the other hand, jumped from approximately 1.3300 to as high as 1.3504, a welcomed development for those betting the Euro-zone holds together. Still, considering the gains by the other majors, the Euro’s lack of conviction on the move higher is concerning. As such, it is of my belief that this is a move to be faded – the central banks’ decision to intervene shows that conditions are deteriorating ‘behind the scenes.’ But what?

Last week I noted, “the Euribor-OIS 3-month spread, the rate at which Euro-zone banks lend unsecured funds to one another, is pushing highs unseen since 2009; in terms of the trend, the last time the Euribor-OIS 3-month spread was on the rise and was this elevated was the week after Lehman Brothers collapsed in September 2008. This is a very alarming development and perhaps a harbinger of ‘bigger things’ to come. I fully expect a major institution – either the European Central Bank or the International Monetary Fund – to step in and attempt to add liquidity to the markets in the coming weeks.”

The move today satisfies this expectation. With the cards on the table now, the rotation of funds into riskier investments is unlikely to be sustained beyond a few days; this isn't the start to a bull rally. The problem with the Euro-zone and the global financial system at the moment is not liquidity; it is solvency. If sovereigns are unable to lower their borrowing costs, it will not matter how much liquidity is pumped into the system. Overall, this move is viewed as a development to buy Euro-zone leaders time, nothing more, and will be viewed as a false breakout as such.

24-Hour Price Action

Key Levels: 14:25 GMT

Thus far, on Wednesday, the Dow Jones FXCM Dollar Index is much lower, trading at 9830.49, at the time this report was written, after opening at 9935.96. The index has traded mostly lower, with the high at 10018.67 and the low at 9801.00

--- Written by Christopher Vecchio, Currency Analyst

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