FOREX: Currency Markets May See Knee-Jerk Volatility as Trade Volumes Shrink

Key Overnight Developments

• Japanese Yen Slumps on Profit-Taking After Yesterday’s Advance
• British Pound Spikes Higher as Trade Volumes Amplify Volatility
• NZ Dollar Gains as Money Supply Sees Smallest Drop in 13 Months

Critical Levels

Currency markets kept to narrow ranges in the overnight session as trading volumes wound down ahead of the Christmas holiday in most of the world’s top banking centers. The Euro oscillated in a narrow range above the 1.31 figure. The British Pound popped higher late into the session to add 0.3 percent against the greenback in what appeared to be a move similar to yesterday’s spike in the Japanese Yen, owing mostly to the amplifying effects of thin liquidity rather than a specific catalyst.

Asia Session Highlights

The New Zealand Dollar narrowly outperformed, adding 0.2 percent on average against the major currencies after the Money Supply shrank at the slowest pace in 13 months in November. The outcome hints inflationary pressure may begin to pick up after the yearly CPI figure hit a six-year low in the third quarter, opening the door for rate hikes in 2011. The Reserve Bank of New Zealand will add 56bps to benchmark borrowing costs over the next 12 months according to traders’ priced-in expectations.

The Japanese Yen moved lower against the spectrum of its top counterparts – with the most profound losses noted against the Kiwi and the Swiss Franc – as the currency retraced some of the equally impressive and difficult-to-explain advance in yesterday’s trade. The currency had gained 0.6 percent on average, marking the largest daily advance in three weeks, on what appeared to be liquidity-driven volatility.

Euro Session: What to Expect

The economic calendar is essentially negligible and the top European markets will be closed for the Christmas Eve holiday, pointing to choppy trade amid thin liquidity conditions. Indeed, using the CME EUR/USD futures contract as a proxy – trading volumes have nearly halved since just over a week ago on December 14th. We will stick with our existing exposure, keeping an eye out for knee-jerk volatility.

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