Currency Markets in Flux as Interest Rates Begin to Overshadow Risk Trends

Key Overnight Developments

• Japan's Trade Surplus Shrinks in November But Trend Points Higher
• Bank Of Japan Builds on New Dovish Posture in Monthly Report


Critical Levels



The Euro and the British Pound consolidated near familiar levels in overnight trading, oscillating near last Friday’s levels to start the trading week. We remain short EURUSD at 1.4881 and short GBPUSD at 1.6648.

Asia Session Highlights



Japan’s Trade Balance surplus registered at 373.9 billion yen in November, narrowing from 805.4 billion in the previous month. Looking past month-to-month volatility at the annual trend in trade flows, however, the result amounts to a 601.4 billion yen expansion from the -227.5 billion deficit recorded in November 2008. Indeed, the headline trade balance figure has been inching higher since bottoming in January as imports bore the brunt of sagging labor markets while global fiscal mitigated the decline in export. This time around was no different as overseas sales slipped -6.2% while domestic purchases of foreign goods slumped -16.8% from the previous year. Although the jobless rate has declined recently, this can hardly be called an improvement considering the lower headline owed to discouraged workers exiting the labor force rather than added hiring, which would seem to suggest that current trade patterns will persist as imports remain lackluster. It remains to be seen if the 600 billion yen allocated to boosting job growth in the government’s new stimulus plan will have a meaningful impact.

The monthly report from the Bank of Japan said the economy was “picking up” but policymakers conspicuously kept their forecast for growth unchanged after upgrading for three consecutive months. While subtle, this could be a reflection of the central bank’s new-found dovish posture that emerged at last week’s monetary policy meeting. As we discussed in detail in our Japanese Yen weekly forecast report, Maasaki Shirakawa and company may be starting to cave in to pressure from the Ministry of Finance to continue on with its liquidity-boosting asset purchase programs, which carries bullish implications for USDJPY.


Euro Session: What to Expect



The economic calendar carries no significant event risk in European trading ours, leaving currency markets to find their bearings after last week’s major developments. The changing outlook for the US Dollar is easily the top story for the time being: the greenback pushed sharply higher against the spectrum of its major counterparts last week after the Federal Reserve said that “deterioration in the labor market is abating,” which traders took as validation of the boost to the priced-in Fed rate hike forecast over recent weeks that was set off by better than expected outcomes for November’s nonfarm payrolls and retail sales reports. The US central bank is widely expected to look at the jobless rate as the key gauge for timing a reversal of its ultra-loose monetary stance, and the market clearly took notice as traders priced in 81 basis points in rate hikes over the next 12 months by Friday, up from just 52bps at the beginning of December.

Elsewhere, concerns over possible intervention in the Swiss Franc exchange rate were set off as EURCHF slipped below 1.50, long believed to be the threshold of the SNB’s comfort zone; meanwhile, the correlation between the Australian and New Zealand Dollars and the MSCI World Stock Index began as attention shifts to a suddenly more timid RBA and an unexpectedly firmed RBNZ. The common thread in all of this appears to be a move away from the risk versus safety dichotomy of the past two years, with monetary policy starting to re-take the forefront.

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