Daily FX Market Roundup 12-31-12

US Falls Off Fiscal Cliff, but FX Traders Unfazed – Here’s Why
EUR: Held Back by End of Year Fixing Flows
GBP: Aiming for its 1 Year High?
NZD: Best Performing Currency
AUD: Upward Revision to Chinese Manufacturing PMI Numbers
CAD: Oil and Gold Prices Rise More than 1%
JPY: Japanese Markets Closed but Yen Extends Lower

US Falls Off Fiscal Cliff, but FX Traders Unfazed – Here’s Why

It is New Year’s Eve and investors want something to cheer about but unfortunately they will have to wait. While there has been a major breakthrough in the talks in Washington, a deal won’t happen before midnight tonight because the House doesn’t plan to hold a vote this evening. This means that the U.S. economy WILL fall off the Fiscal Cliff but the price action in the financial markets suggests that investors aren’t worried. There’s a very good chance that President Obama will announce a deal later this week sparing most American families from higher taxes in 2013. Investors are willing to grant Washington few day extension especially with markets closed on Tuesday. One or two extra days won’t make a difference especially since tax hikes will be felt gradually. Currencies and equities soared today after Senate Republican Leader Mitch McConnell said they are “very, very close” to reaching an agreement on taxes. These comments came shortly after President Obama took the podium to say that a deal is in sight but it’s not done. This infuriated Republicans but did not stop McConnell from confirming that progress is being made. Senior officials from both sides said they agree to extend Bush era tax cuts for individuals making less than $400,000 and households with less than $450,000. Most likely unemployment benefits will also be extended for another year as well. This is a huge concession for both sides and this new attitude of cooperation will be essential over the next few months as negotiations shift to spending cuts and the debt ceiling. We are still waiting for a formal announcement to be made but the rally in currencies and equities indicate that a deal is already done in the minds of investors.

While a formal announcement will probably drive currencies and equities even higher, it needs to happen this week, otherwise the market will lose patience because U.S. budget problems are not in the rearview mirror. It shouldn’t take long for investors to realize that automatic budget cuts, known as sequester still need to be addressed along with an increase to the debt ceiling and neither will be easy discussions. So while a formal deal would remove a major uncertainty in the market by ensuring that tax cuts are extended for 99% of Americans, it may not pave the way for a clean and consistent rally in risk in the coming year. While a Fiscal Cliff deal will help the U.S. economy avoid recession, the debt ceiling has already been reached and there’s only so much time Treasury Secretary Geithner can reshuffle accounts to pay the bills. Also, since a formal announcement hasn’t been made yet, that there is still a risk that the talks could break down and if that happens, the gains that we saw today will evaporate instantly. Hopefully that’s not the case and we can start the year on firm footing.

EUR: Held Back by End of Year Fixing Flows

On a day when most of the major currencies traded higher against the greenback, investors may find the weakness of the EUR/USD peculiar. Not only did EUR/USD failed to participate in the rally but it also saw quite a bit of intraday volatility. While most European markets were closed for trading, end of year fixing flows played a role in the EUR/USD’s wild swings. It is the end of the month, quarter and year and oftentimes that can lead to increased volatility in currencies. We won’t be publishing any articles on Tuesday January 1st but when the financial markets reopen for trading on Wednesday, final Eurozone PMI manufacturing numbers will be released along with German consumer prices. These second tier reports will most likely be overshadowed by the markets reaction to the U.S. budget negotiations but even so, these economic reports are important as investors continue to watch how Europe rises from its sovereign debt crisis. No major revisions are expected to be made to the PMI reports but a decline in German producer prices raises the possibility of softer CPI numbers. For the first time in years, it finally feels like Europe’s sovereign debt crisis could be in the rearview mirror. European bond yields have held steady over the past few months and German stocks climbed to their highest level in nearly 5 years. The European Central Bank’s OMT program effectively reduced stress in the region even though no one has asked the ECB to activate the program. While economic growth is expected to remain slow in the coming year, we believe that the decline in sovereign risk will encourage investors to return to Eurozone assets in 2013.

GBP: Aiming for its 1 Year High?

The British pound rose for the second trading day in a row against the U.S. dollar and euro. The only piece of U.K. data on the calendar was third quarter housing equity injection. According to the Bank of England, Britons injected a total of 8 billion pounds into their housing equity in Q3, down from 9.4 billion pounds. In other words, mortgage payments by Britons exceeded new borrowing by a net 8 billion pounds, the smallest amount since early 2010. While this may suggest that home owners are repaying their mortgages faster, the BoE believes that the new injections mostly reflect weaker housing demand. The lack of momentum in the housing market is one of the U.K. government’s greatest problems because their ambitious Funding for Lending Scheme has failed to gain any traction. This week, we’ll learn a lot more about how the U.K. economy is faring with manufacturing, service and construction sector PMI numbers due for release. For the GBP/USD to crack above its 1 year high of 1.6309, we would either need to see a very positive reaction to the U.S. Fiscal Cliff negotiations or strong U.K. PMI reports.

NZD: Best Performing Currency

All 3 of the commodity currencies traded higher against the greenback today but the move in the New Zealand dollar was particularly impressive. NZD/USD rose more than 1% despite the lack of economic data and news flow. In fact markets in Australia and New Zealand were closed on Monday and will remain closed on Tuesday. The strong rally in the NZD/USD reflects the currency’s sensitivity to risk appetite and the market’s hope for a Fiscal Cliff deal. The only piece of economic data released overnight was the final HSBC flash manufacturing PMI report for China. According to the bank, manufacturing activity increased more than initially estimated in the month of December. The decline in new export orders and increase in total new orders suggests that growth is being fueled by domestic and not external demand. Nonetheless, stronger manufacturing activity in China is good news for the entire Asia Pacific region including Australia. We believe that one of the biggest risks for 2013 is stronger and not weaker Chinese growth. Many economists are looking for China to slow in the coming year but as we have seen with the latest data, the country has a knack for beating expectations. The government’s official manufacturing report will be released this evening and is in fact the only piece of economic data scheduled for release over the next 24 hours. Since most markets are closed on Tuesday for New Years, the first opportunity for the AUD/USD to react will be at 1am ET on January 2nd at which time Australia’s manufacturing PMI numbers will also have been released.

JPY: Japanese Markets Closed but Yen Extends Lower

With Japanese markets closed Monday, Tuesday and Wednesday, it will be a quiet front of the week for Japan. No economic data is scheduled for release until Thursday at the earliest. Yet this did not stop the Japanese Yen from extending lower against all of the major currencies today. After one brief pause on Friday, USD/JPY continued to power higher. The most popular call for 2013 is to short the Japanese Yen with the targets from analysts ranging 87 to 90. Since LDP leader and current Prime Minister Abe started to talk about pressuring the Bank of Japan to increase its inflation target, USD/JPY has been on a tear. Since mid November, USD/JPY appreciated as much as 700 pips or nearly 9%. There are fundamentally sound reasons for the Yen’s weakness. The Japanese economy is extremely weak, the country is running a trade deficit and the threat of slow growth in the coming year will make any recovery difficult. As a result, even without Abe’s pressure on the BoJ to increase asset purchases aggressively, the central bank will need to ease monetary policy further in the coming year. In January, the BoJ is expected to acquiesce and raise its inflation target. USD/JPY could extend higher in the lead up to the January 20th announcement but there’s no question the trade is getting crowded however so it may be better to buy on a pullback than to chase it higher.