Will The Fed Flip the Rally in Risk FX?

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Markets Driver Jan. 30, 2013
EURUSD and USD/JPY hit fresh highs
EZ confidence improves US yields above 2%
Nikkei 2.28% Europe 0.02%
Oil $97.50/bbl
Gold $1667/oz.

Europe and Asia:
JPY Retail Trad 0.4% vs. 0.4%
EUR Consumer Confidence 89.2 vs. 88.7
GBP Mortagage approvals 56K vs. 55K

North America:
USD ADP 164K 8:15
USD GDP 1.1% 8:30
USD FOMC 14:15

Its been a barrier busting night for EURUSD and USDJPY as both pairs hit fresh yearly highs amidst continued investor optimism and accelerating flows into the risk trade. After consolidating for most of the late North American and early Asian session the EURUSD finally broke through the psychologically key 1.3500 figure taking out the reported option barriers at that level as it reached its highest level since December of 2011. The run higher in the pair occurred despite another weak GDP reading from Spain with the flash report coming in at -0.7% versus -0.6%.

However, as we noted earlier, the EURUSD has not been trading on economic data for quite some time, but rather on investors optimism regarding the stabilization of the financial sector in the region’s periphery economies. With EZ sovereign debt yields continuing to compress and converge the currency pair has benefited from the continuing unwind of the “euro breakup” trade. This was clearly evident in today’s session as euro set fresh highs on many of the crosses including EURGBP EURJPY and EURAUD.

The latest results of the Italian auction which saw the country sell EUR 3.5bln 10-yr BTPs at the lowest yield since October 2010 also helped to boost investor confidence. The benchmark 10 years saw their yield drop to 4.17% versus 4.48% the period prior.

Currency market investors are clearly betting that the easing of the financial conditions in the region will translate into a pick up in the economic activity for the Eurozone as the year develops. In the meantime, the EURUSD is clearly enjoying strong upside momentum and may target the 1.3550 level as the day proceeds and further option barriers fall by the wayside.

Meanwhile USD/JPY hit fresh yearly highs as well as US 10 year Treasury yields ticked up above the 2% mark. USD/JPY is very sensitive to the UST/JGB spread and US yields continue to rise on hope of further economic recovery the widening of the spread could push the pair higher.

As we’ve stated many times in the past, we believe that that next leg up in the USD/JPY rally will be contingent on US economic performance rather than any additional policy measures by the Japanese. Therefore, today’s slew of economic reports during the North American trade could prove pivotal to the rally in USD/JPY. The market is anticipating weaker results from both ADP and GDP data with ADP expected at 164K and GDP at 1.1%. However any upside surprise could prove positive for USD/JPY taking the pair to 91.50 as the day proceeds.

The FX market is now clearly a momentum phase with eco data having only a tangential relationship to currency prices. Generally under such conditions prices tend to overshoot targets before making any corrections. Therefore the momentum flows in Europe are likely to continue into North American trade unless the markets are hit by some exogenous shock.

One possible risk is the FOMC statement due at 17:15GMT today. Although the market anticipates little fresh information and the meeting will not be followed by a presser, any change in the language that suggests the Fed is considering a curb on its QE policies could cause as quick reversal in today’s trade.

Boris Schlossberg
Managing Director

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