Euro Hammered as Germans Try to Limit ECB Supervision

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Market Drivers September 19, 2012
BOJ doubles QE but scope still small
Euro dives on fears of watering down banking union
Nikkei up 1.19% Europe up 0.8%
Oil at $95/bbl
Gold at $1773/oz.

Europe and Asia:
AUD Westpac Leading Index 0.4% vs. 0.5%
JPY BOJ Rate Decision QE Increases to 10T yen
GBP BOE Minutes 0-0-9

North America:
USD Housing Starts 8:30
USD Building Permits 8:30
USD Existing Home Sales 10:00

Risk FX hit a snag in early European session today as selloff in equities and reports that some German lawmakers proposed a weakening of the banking union weighed on the EUR/USD pushing the pair back towards the key 1.3000 level by mid-morning trade. A newswire report that some German ruling coalition members are seeking a way to limit ECB supervision only to systematically important banks, triggered a selloff in the EURUSD as traders worried that such a move would water down the current banking union proposal.

Some analysts consider the banking union idea to be of similar importance as any of the policy actions on the sovereign debt front, viewing the region’s financial sector as a critical foundation for a sound currency. Therefore any proposals to diminish ECBs supervisory authority is viewed very negatively by the market. The euro found temporary support near the 1.3000 level but given the turn in sentiment the pair is likely to break that barrier as shorts plumb for sell stops around the big figure.

Meanwhile in Japan the BOJ surprised the market by increasing its QE program sending USDJPY through the 79.00 figure, but the pair had difficulty holding that level as risk off flows in early European session sent it back below the barrier. The BOJ doubled the scope of its QE program increasing it to 10 Trillion yen with Governor Shirakawa noting that board members were concerned about the economic slowdown in China.

Interestingly enough Shirakawa stated that the ongoing Island dispute with China had no bearing on today’s decision, although the political fallout from the recent hostilities could prove to be a much greater challenge to Japanese growth going forward. The move was welcomed by Japanese lawmakers with Azumi noting that Japanese recovery was being endangered by the slowdown in global growth and the relentless rise of the yen.

Nevertheless the latest move by the BOJ is a mere pittance in relation to Fed recent announcement of additional 40 Billion dollars of new QE per month. As it stands now the BOJ program is only one tenth the side of the Fed’s and therefore is unlikely to have a sustained impact on USD/JPY rates.

Still the move the BOJ underscores the gravity of the current Japanese economic situation and suggests that policymakers are clearly concerned about the negative effects of strong yen on Japanese growth. It may also hint at the possibility that the BOJ will expand its balance sheet in a much more dramatic fashion as the year comes to a close in order to further weaken the yen. For now the pair appears to have stabilized at the 79.00 level and could inch higher as the day progresses and North American traders have a chance to digest the news.

In North America today the calendar carries housing data which has been the one bright spot in the economy and with trades looking for a modest uptick in Existing Home sales to 4.57M from 4.47M the period prior. An improvement in housing may be the catalyst for a fresh wave of risk flows and could help push USD/JPY higher. The pair faces stiff resistance at 79.25 but if it can clear it a run towards 79.50 could be materialize as further yen selling kicks in.

Boris Schlossberg
Managing Director

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