EUR tumbles ahead of ECB decision
The single currency started the week on the back foot as the ECB decision looms. The euro was down roughly 0.30% against the US dollar but lost even more ground against high quality commodity currencies such as the Aussie and the Kiwi, which gained 0.30% and 0.45% respectively. For the past two weeks the single currency has been trading in a volatile range as investors awaited the European Central Bank’s penultimate meeting of the year. Although there is absolutely no doubt that the ECB will trim its monthly bond purchase, which currently stands at €60bn/month, the date of the announcement is still quite uncertain.
There is a high probability that Mario Draghi will make this announcement on Thursday as waiting longer would send a negative signal to investors. Indeed, waiting until December will suggest that the ECB is not happy with the current economic conditions in the EU. However, In order to avoid throwing the cat among the pigeons, Mario Draghi will likely adopt a very cautious tone and will also reiterates that the ECB could potentially increase again its support to the economy should the situation require. Indeed, is there is one thing that Draghi wants to avoid is to trigger further EUR appreciation as it would both damage the economic outlook but, most importantly, it will add pressure on an already anaemic inflation.
Looking at the market this morning, EUR/USD realized volatility has reached its lowest level since August 2014 which suggest that investors are too worried. However, the 1-week implied volatility has spiked to 9.36%, compared to 6% a week ago. The 1-week 25 delta risk-reversal measure rose to 0.53% indicating that investors are buying protection against an upside move in EUR/USD. On the longer-term, it is worth mentioning that the 6-month 25 delta risk reversal measure has returned in negative territory, sliding to -0.17%. This move below the neutral threshold is clear indication that investors await a reversal of EUR/USD within the next 6-month.
In addition, the appreciation of the Swiss franc against the single currency also suggests a certain tensions among investors. Although we believe that the market is almost done pricing in the upcoming QE reduction, the single has still upside potential, though limited thanks to political uncertainties.
Abe win give USD/JPY a boost
In Japan Prime Ministers Shinzo Abe ruling LDP-Komeito coalition was handed a resounding victory in the Lower House elections. Upstart opposition Party of Hope failed to converted general popularity into votes but did end up splitting the opposition vote making its easer for Abe to obtain a 2/3 majority. Despite the fact that Abenomics does have much room to debase the JPY, USDJPY rallied to 114.10 result on the removal of political uncertainty. Looking forward Prime Minister Abe will run again for the LDP leadership next year while the BoJ will be dominated by dovish members as BoJ governor and deputy governor’s selection next April will be under Abe strong control. Moving forward the fate of USDJPY depends less on BoJ policy and more the outlook for the Fed.
Growing expectations for a positive turn in US data has added to higher US interest rates. In addition, positive developments over a tax reform and continuity in naming the next Fed chairperson should keep USD firm against the JPY. Finally Japanese’s institutional investors knowing lower interest rates and YCC are unlikely to changes will further search overseas of yields. FX Asia is looking increasingly balanced with higher US yields on one side and solid global growth (expected around 3.0% 2017) and trade data on the other. We suspect that the risk is skewed towards USD upside. US data momentum is expected to reverse softness starting with 3Q GDP and PCE this week. However, given the recent strength of upside surprises in export momentum we anticipate cyclical softening which will send Asia FX lower.
