29 November 2011 at 9:51 GMT
“Apart from the known and the unknown, what else is there?” – Harold Pinter
The broad speculative market is in the process of deleveraging, along with banks globally. The reduction in liquidity that this generates means that volatility is exaggerated and the impact of ‘events’ is likely greater. Along with the ‘known unknowns’ (events that we know we don’t know the outcome of) of the European bond auctions, Eurogroup and Ecofin meetings, the UK Autumn statement and the US employment report on Friday; there are potentially a number of ‘unknown unknowns’ (things that we don’t know that we don’t know) – or the unexpected in this instance, as well. In this respect market positioning is potentially the biggest risk.
The risk reversal in USDJPY is currently trading with a positive skew in the 1 month duration (effectively this means that it is more expensive to buy options for, or participate in, up moves than down moves via currency options). This is the first time that the ‘skew’ has been this way round in about 7 years, as historically the more aggressive moves in USDJPY have been to the downside. In essence we can take this as a suggestion that the market is more concerned about a move up in USDJPY, than a move down, at least up until the end of the year. This is all happening while there are a number of macro economic risks for Japan and the JPY (including the increasing concerns about fiscal sustainability and slowing economic growth) and it is likely that the predominant driver of the ‘fear’ of a topside move is due to positioning.
Credit ratings agencies are also playing their part in the current market dynamic and after Fitch placed the US on negative watch last night and Moody’s confirmed that it is considering lowering the ratings on 15 EU nations as well as 87 banks in these countries, French press reported this morning that S&P may cut France’s AAA rating in the next 10 days.
In Australia, despite a deterioration of the fiscal outlook and a lower GDP forecast trajectory from the treasury, AUD traded higher overnight as the US outlook downgrade squeezed positions. I still see potential for AUD to move significantly lower over the short term but again, it is likely to be volatile into the year end.
Plan A+
For the day the focus will be on UK Chancellor Osborne and his Autumn Statement, in which he is expected to announce a series of ‘micro-measures’ in an attempt to stimulate growth against an increasingly troubled global backdrop. The measures are likely to include a form of credit easing and ‘growth positive’ selective tax boosts which amount to a ‘Plan A+’ rather than the Plan B of deferring some of the austerity and relaxing the deficit reduction target.
Eternally Financing Systemic Failure?
In addition to the focus on the UK we also get the Eurogroup and Ecofin meetings today and tomorrow in the Eurozone, where debates are likely to centre around an agreement for the release of the sixth aid tranche to Greece and the development of proposals to boost the European Financial Stability Facility's firepower. In reality, however, so far the EFSF has been spectacularly unsuccessful in the current environment with demand remaining low, only EUR16 billion has been placed so far and the yields on those bonds has backed up over 100bps since the auctions – not exactly a glowing reference or an indication of the market's desire to assist in the Eurozone desire to leverage their firepower!
In that respect the Eurozone auctions this week will be very closely watched. After a disappointing auction for EUR567 million yesterday, Italy comes back to the market today asking for EUR8 billion. Italian yields in reaction to this, having already established themselves firmly above 7 percent, will be a key barometer of sentiment on the day. Whilst the primary known unknowns are coming from the Eurozone and the UK, I still favour EURGBP lower in the current environment.