FX markets started the week just where they left off - by keeping volatility high. Before Japanese traders could even sit down at their desks, both the EUR/USD and the GBP/USD skyrocketed creating monstrous gaps of 100 points and more. The wild frenzy of buying was primarily driven by option players – who having sold volatility extremely cheaply over the past 3 months - now found themselves facing massive losses and scurried to cover their exposure in the spot market. With the last of speculative demand finally sated, both the euro retraced their gains and promptly filled the gaps in early London trade.
Unsurprisingly, the breach of the psychologically important 1.3000 level elicited cries of concern from European Finance Ministers led by France’s Thierry Breton who said the Eurozone finance ministers will discuss euro’s strength at the Eurogroup meeting. The rise in the euro presents a particularly vexing problem for EZ policy makers. On the one hand it acts as a positive deflationary force by making energy and import items cheaper for the regions 300 million plus consumers. On the other hand it hurts the competitiveness of the vital export sector which has been responsible for much of the recent economic growth. Although it is unlikely that the EZ fiscal authorities will be able to force their monetary counterparts to hold off on the planned rate hike by the ECB on December 7th, at the very least the region’s politicians will demand that the central bank cease and desist from any further tightening until the impact of the higher euro on EZ economic data is better understood.
Meanwhile in UK, housing data continues to show no signs of slowdown as BBA mortgage lending figures printed in line at 75K versus 74K expected. The pound has followed the euro to set 23 month highs against the greenback despite last week revelation of a surprisingly dovish 7-2 vote by the BoE. Yet until such time that UK eco data shows marked weakness, trader sentiment will bet on further rate hikes by the BoE and that in turn will fuel the unit higher against both the dollar and the yen.
This week sets up a very interesting scenario in the market. Given the enormous momentum generated by last week’s moves, any hint of weak US data could fuel a stop driven frenzy towards 1.3300 on the EUR/USD and 1.9500 on GBP/USD. However, if US news beats expectations or European data proves negative a retrace may well be in order. Dealers having printed shorts to all the momentum players over the past few days will be eager to use any excuse to buy them back. Therefore, the volatility of last week is likely to continue as market participants adjust to the new price regime after months of listless, meandering range trading.