The primary factors affecting the fx market the previous week was- ongoing sovereign debt saga in Europe’s PIG, concerns over continued PBoC tightening measures, and geopolitical turmoil on Korean peninsula.
Early on Asian session on Monday, the market reacted to positive developments in the above three factors.
During the weekend, Ireland and EU/IMF reached a bailout agreement. The financial package will cover financing needs up to EUR 85b but unusually EUR 17.5b of it will come from Irish government cash reserve and from the national pension fund. So that's effectively, EUR 66.5b instead of EUR 85b which is lower than markets expectation. An extra year is also given to Ireland to reduce its deficit from current 32% to 3% of GDP, that is, by 2015.
In China, PBoC Deputy Governor Ma provided some relief to anxiety over further tightening, suggesting the central bank is comfortable with rapid credit and monetary growth as well as rising inflation pressures, with some of the recent actions already feeding into the markets. More importantly, Ma made no mention of continued policy tightening; instead suggesting PBoC will rely on bill sales to mop up excess liquidity.
On the Korean peninsula, the joint US-South Korea naval exercises are being staged as planned with no interference from the North, just as the leadership in Seoul pledges to bolster defenses of the shelled islands and China continues its campaign to bring Pyongyang back to the bargaining table.
But by European session, the markets have wasted little time with risk is on again, and are now taking aim at the Latin region of Europe; with focus has been firmly on Spain and Portugal as in recent days the Spanish 10-year yield down for the eleventh day in a row for a yield of 557 bp Belgium also came into picture as reported that Belgium has quietly be racking up debt like nobody else... or is that like everybody else! Debt-to-GDP is just about 100% now as the country has run around like a chicken without a head - quite literally, given that there has been no government in place - since April of this year where the Leterme government resigned. A couple of poor auctions for three and six month paper have put pressure of the sovereign CDS of Belgium, which are up 21 bp on the day and it now costs 202 bp to insure Belgian sovereign debt.
By Wednesday, during the European session, risk sentiment was reversing as there were talk of European Central Bank (ECB) may alter the EUR750 billion contingency fund in order to buy assets in a quantitative easing effort that would also serve to prop-up the bond markets in embattled countries like Portugal and Spain. Rumour that the ECB about to join the Fed and the BOJ by printing more money and hoping that all our problems will go away
On Thursday, ECB President Trichet was ambiguous about the degree of support the ECB is willing to lend to the peripheral nations during his monthly press conference, it has delayed its exit policy and increased its special liquidity operations until at least the first quarter of next year. This eases the immediate pressure on the peripheral nations' banking sectors, some of which remain addicted to ECB funding. Trichet also said that its bond buying programme would remain open.
ECB was then reported to be buying Irish and Portuguese bonds aggressively leading up to the ECB meeting. This complicates its strategy regarding the peripheral nations as it is saying one thing and doing another.
On Friday, US Dollar plunging across the board, weighed under a disappointing US Non-Farm payrolls report. U.S. November employment report came up lame of economists' expectations - Nonfarm Payrolls +39k vs. exp. 150k; Unemployment rate 9.8% vs. exp. 9.6%.
It appears there has been a shift in the market's reaction to poor data with regards to the U.S. dollar. Over the last few years such a scenario would have seen considerable risk aversion. Typically, the response has been significantly lower equities, higher bonds (lower yields), higher USD vs. other currencies - outside of the JPY or CHF (risk averse currencies), and mixed vs. commodities depending on their mood. In terms of Friday's price action, equities are only marginally lower, yields initially fell dramatically but have since stabilized, commodities have soared and the USD has been crushed.
Thus the post-QE2 environment, it seems the dynamics have changed for the dollar whereby positive US data is good and negative data is bad.
GBP/USD after breaking the previous week low bottom at 1.55 handle. From Tuesday onward the pair pushed upward to close by the end of the week just below the 1.58 handle at 1.5770 or at 38.2%.
From Tuesday, the pair move in similar pattern every day i.e. On London session, the pair went south but by New York session it recovered and reacted upward.
For the coming week, cable is expected to take out the 1.58 handle with resistance at 1.585 and the next resistance at 1.59. On the downside support is at 1.5670.
