Bossa Nova, It Ain’t

A new month has begun but the sounds are the same. Ahead of tomorrow’s US jobs report, we should anticipate generally consolidative activity.  The dollar is a bit bid in Europe, moving above JPY80 and seeing follow through buying against the euro after staging a recovering in NY. Yesterday we noted here that the dollar selling in Europe was unlikely to continue; today we suspect that the dollar buying activity seen in Europe will not continue through the North American session.
Yet, we want to maintain that the near-term US economic data is of little real significance. How can it be when the fiscal cliff is looming and even under various compromise scenarios, the economy will take a hit in Q1 13? Ending the payroll savings tax break alone would be expected to reduce disposable income by something on the magnitude of $100 bln.
Within the broad $1.28-$1.32 trading range, the euro has traced out a tighter $1.2880-$1.3020 near-term range. The increases European paper held by US money market funds, the improved deficit picture in many euro area countries, compared with a year ago, Spain’s second consecutive monthly current account surplus and beneficiary of portfolio capital inflows for the first time in more than a 1 1/2 years have helped support the euro.
On the other hand, there is a sense that the calm that is being experienced now is very fragile and is bound to come to an end before the year is up. There seems a contradiction between market perceptions that the debt trajectory in Spain is not sustainable and its refusal to ask for assistance.
This has to be resolved just as much as the US fiscal cliff needs to be addressed. A key difference is that there is a clear deadline in the US as the automatic measures (read tax increases and spending cuts) are triggered on January 1, while the limit on the situation in Europe appears more flexible. Europe’s challenges also seem more multifaceted. What to do about Greece? Cyprus? Portugal ?  Banking Union? Give Brussels more authority over national budgets?
Given the ugly contest, it is understandable that the euro is range bound against the dollar. However, the dollar’s gains against the yen are a bit more surprising. Interest rate differentials between the US and Japan have narrowed and this often corresponds with yen strength.  The S&P 500 is near 2-month lows, suggesting a more cautious investment climate, which sometimes also benefits the yen.
The BOJ did not impress the market with its JPY11 trillion expansion of its asset purchase plan. The economic data does suggest Japan’s economy is contracting, but yen strength has not been about the Japanese economic performance for years. Moreover, the capacity for a stronger policy response is limited. After expanding its balance sheet for the unusual second consecutive month, the BOJ is out of the picture for a little while at least. For its part, the Noda government is seems to sinking by the day.  The opposition appears strong enough to block any initiative but not stronger enough for defenestration.
There does seem to be a speculative angle at work. As noted in our weekly review of the Commitment of Traders, the net speculative position at IMM futures swung from long 30k at the start of October to short 20k contracts at the end of the month. This seems to be a fair representation of short-term and momentum traders more generally.
There is some talk that the BOJ is planning on large scale intervention. A year ago, Oct 31, 2011, the BOJ intervened massively, buying around $100 bln. They could do it again.  However, it still does not seem very likely. Admittedly there is a logic to intervening with the market, not against it. Yet apparently Japanese officials do not find the logic compelling.
The yen bears are likely to struggle to establish a foothold above JPY80.00, and even then the JPY80.50 may be prove quite formidable.  However, they may not be squeezed out unless the JPY79.20 area breaks.
New month old pattern.
This post was originally published at Marc To Market and is reproduced here with permission.