FX -Rally in Yields Drives Everything Up

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Market Drivers December 12, 2016
US Yields Explode
Italian Government backstops Monte Dei Paschi
Nikkei 0.84% Dax -0.09%
Oil $54/bbl
Gold $1154/oz.

Europe and Asia:
JPY Machinery Orders 4.1% vs. 1.3%

North America:
No Data

It’s been a boisterous start to the week as rally in yields across the G-7 universe pushed both USDJPY as well as most of the majors higher in lively Asian and early European trade.

USDJPY took out the 116.00 figure in very early London dealing as US yields on the 10 year crossed the key 2.50% level reaching a high of 2.51%. The pair dipped back into the 115.00’s on exporter offers but remains well bid into the European morning as fixed income markets continue to sheds bonds pushing rates higher across the G-7.

In Europe the bunds were lower by 25 basis points which helped to underpin the EURUSD as the pair made a run towards the 1.0600 figure. The rally fizzled ahead of that level but the pair could make another attempt as the day proceeds.

The euro was also boosted by news out of Italy, where the government made assurances that all deposits of the troubled Monte Dei Paschi bank will be guaranteed. Monte dei Paschi, one of the oldest financial institutions in the world has been racked by bad debt problems and undercapitalization concerns for more than a year. While the Italian government did not offer to recapitalize the bank, it did suggest that it stood ready to provide a 14 Billion euro lifeline in case private refinancing efforts failed.

The news reassured investors and was one of the factors for EURUSD’s recovery. The pair has now tested the key support level of 1.0500 twice and so far has managed to hold off the sellers. A big part of the reason for recent weakness in the pair has been the relentless rally in US yields. Conventional wisdom in the market indicates that the Fed will not only hike by 25 basis points this week as expected but will also shift its stance to a more conventional monetary policy as it begins the normalization process.

There is, however, good reason to be skeptical of this view. With rates having risen so high so fast the Fed may be inclined to be much more cautious in its forward guidance than the market believes. In fact some analysts are forecasts that just as the ECB did a “dovish taper” last week, the Fed may do a “dovish rate hike” this week. One simple way that the Ms. Yellen and company could achieve that task is to simply keep or even lower its rate path indicating that the Fed will more than willing to sit on the sidelines after the expected rate hike this Wednesday.

With no eco data on the docket anywhere in the G-7 today the currency market will likely to pivot off the fixed income prices for the rest of the day. But if US yields don’t push higher as the day proceeds USDJPY would be ripe for a profit taking selloff back to 115.00

Boris Schlossberg
Managing Director

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