FX Daily Planet: London Open

FX Daily Planet: London Open

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In the early Asia session, the Fed announced a 25bp hike in the discount rate. FF futures and S&P500 futures were sold off after the announcement. Given this development, USD rallied sharply against the G-10 currencies; USD/JPY rose to 92s, which is the highest since January 12st, and EUR/USD plunged to mid-1.34. USD continued to trade firmly as S&P500 futures remained in the red and Asian equities broadly declined. JPY outperformed non-USD G-10 currencies as well at the cost of some European currencies; GBP and SEK declined 0.7% against USD respectively. USD/Asia traded higher with the weakness in the regional equity markets. On the FX vol front, short-end USD vols spiked higher by 0.6-0.7 vols on the sharp spot movements with curves flattening. Meanwhile, JPY cross vols were largely unchanged.

The Fed announced a 25bp hike in the discount rate to 0.75% with the spread between the discount rate and the interest on excess reserve rate (which is currently 0.25%) widening to 50bp (we expect the spread to widen to 100bp eventually). Although the timing of the decision was a bit earlier than we expected, it was not something that was completely unexpected. What is more important is that this move should not be seen as a signal of a change in the Fed’s monetary policy stance; Bernanke already emphasized this point in the draft of his testimony on February 10th and the statement that followed the discount rate hike stated that "these changes are intended as a further normalization of the Federal Reserve's lending facilities" and "do not signal any change in the outlook for the economy of the monetary policy, which remains about as it was at the January meeting of the FOMC". In addition to this, three Fed officials, those who provided speeches during the Asia session, insisted repeatedly that this hike does not imply a tightening of monetary policy. Also, the timing of the announcement -- away from an FOMC meeting and alongside the H.4.1 release of Factors affecting reserve balances -- was designed to reinforce this separation of the discount rate spread normalization and monetary policy. We still expect that the Fed will start monetary tightening only in 2Q11.

Going forward, the Greek problem will remain in the center stage of the market during the London Session. Interestingly, despite the German-Greek spread widening yesterday, its negative impact on EUR was limited partly because European equities were traded steadily. Indeed, the correlation between EUR’s effective rate and German-Greek spread and Greek CDS spread has weakened recently. Therefore, we may be reaching the point where we should be cautious on the upside risks in EUR with the scenario that any positive headlines would trigger a short-covering. On the economic data front, Feb.PMIs from the euro area, Jan. retail sales from the UK and Jan. CPI from the US are due for release today.

Overnight news

USD: The Fed announced the discount rate would be increased to 0.75% from 0.50% -- "the modifications are not expected to lead to tighter financial conditions for households and business and do not signal any change in the outlook for the economy or for monetary policy."

USD: Feds’ Duke --"a newly announced increase in the rate the Federal Reserve charges on emergency loans to banks doesn't signal any change in monetary providing amid the global financial crisis."

USD: Fed’s Lockhart – “does not see deficit creating a dollar crisis in near term”, “agrees with "extended period" language and says it should be removed when time is right”, "some reserves will have to be drained before interest on reserve effective as policy tool". “does not see asset sales as best early step or first step in Fed exit”.

USD: Fed’s Bullard – “the moving Fed funds rate should be as far away as it ever was". "For the near term, interest on reserves will probably be policy tool","Market is putting too high of a probability on rate increase this year".

AUD: RBA Governor Stevens said the bank was longer in an emergency mode but cash rates were still around 50 to 100 basis points below normal, and there was less scope for robust demand growth without inflation starting to rise.

JPY: Japanese Finance Minister Kan said the U.S. Federal Reserve's discount rate hike was not negative for Japan's economy as it would weaken the yen against the dollar.

JPY: Dec. tertiary sector activity index was weaker than consensus at -0.3% (cons+0.1%)

USD: Fed data released that the U.S Federal Reserve's balance sheet expanded in the latest week, led by its soon-to-be-ending for the mortgage market.

Today’s watchlist (all times GMT; +11hrs for Sydney, +9hrs for Tokyo, -5hrs for New York)

EUR: Germany Jan PPI (%oya) @7:00 (JPM: -4.0, Cons: -4.0); Germany Fed PMI mfg. flash (index, sa) @8:30 (JPM: 54.1, Cons: 53.9); Germany Fed PMI services flash (index, sa) @8:30 (JPM: 52.8, Cons: 52.5); Fed PMI mfg. flash (index, sa) @9:00 (JPM: 52.8, Cons: 52.7); Fed PMI services flash (index, sa) @9:00 (JPM: 52.9, Cons: 52.5); Fed PMI composite flash @9:00 (JPM: 54.1, Cons: 535); Dec current account (EUR bn, sa) @9:00 (Prev: 0.1)

GBP: Jan retail sales (%m/m, sa) @9:30 (JPM: -1.0, Cons: -0.5)

USD: Jan CPI (%m/m, sa) @13:30 (JPM: 0.3, Cons: 0.3); Jan CPI core (%m/m, sa) @13:30 (JPM: 0.1, Cons: 0.1); Fed’s Dudley speaks @13:00

CAD: Dec retail sales (%m/m, sa) @13:30 (JPM: 0.3, Cons: 0.5); Dec retail sales ex autos (%m/m, sa) @13:30 (JPM: 0.0, Cons: 0.3)

MXN: Banxico rate announcement @15:00 (JPM: 4.50, Cons: 4.50)

Overnight price action

FX: USD and JPY outperformed other G-10 currencies while GBP, NOK and SEK underperformed.

FX vol: Short-end USD vols spiked higher by 0.6-0.7 vols JPY-cross vols were largely unchanged.

Commodities: Oil down 1.3%. Gold down 1.2%

Bonds: Long-end JGBs were sold slightly on the Fed’s announcement (+1bps) with curve steepening.

Equities: Asian equities were met with a broad sell-off; Nikkei -20%, Hang Seng -2.3% and KOSPI-1.7%.

Technical View for the day

The combination of slightly improved fundamental data in the US and persisting problems concerning sovereign debt in southern Europe keeps the USD particularly in favor of the EUR but also across board. This keeps the pressure on the EUR where projected targets against the USD around 1.3100 are still in focus. Given the fact that stock markets are still holding on to their recent gains commodity currencies remain well bid against EUR but crucial barriers at 1.5001 (EUR/AUD), at 1.9101 (EUR/NZD) and at 79158 (EUR/NOK) are in close reach now and could at least trigger an intermediate consolidation in these already stretched trends. It is in this context still advisable to keep a close eye on the S&P500 where key-resistance at 1105 or at 1125 could well trigger a stronger sell-off and only a break above the latter would delay a broader consolidation for a short while. As for the JPY in general, there seems to be a case forming for strong depreciation across board whereas a break above 125.92/126.88 in EUR/JPY and above 92.56/93.12 in USD/JPY would deliver first evidence for this view.

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