Exit the Dragon...Enter EUR and GBP weakness?

Exit the Dragon?
With most of the Asian time zone off for the Chinese New Year celebrations (and Japan closed for National Founding Day), activity and volumes were light in this week's opening session. After a quiet start, however, I would expect this week to bring with it increasing volatility with Eurogroup, Ecofin and G20 meetings the core focus of markets and the core risk for ‘binary’ rhetoric, as far as the markets are concerned.

Political risks rising
Eurogroup (Eurozone finance ministers) meeting today, followed by Ecofin (Finance ministers of the 27 EU states) tomorrow. The main topic for discussion is aid packages for Greece and Cyprus, yet with the Greek situation having ebbed away from emergency, and the Cypriot bailout package unlikely to be agreed until after the elections, the meeting will hardly carry the key to this week’s trading dynamic. Outside of Greece and Cyprus, however, it is the F.I.S.H that remain the key barometer of Eurozone stability. Italy and Spain are embroiled in political uncertainty, with the alleged scandal in Spain and an increasingly uncertain electorate in Italy. France and Holland face the less immediately resolvable challenges of weak and deteriorating economies. In addition, French Banking Reform bill begins its passage through the National Assembly and the European Central Bank president Mario Draghi attends the Spanish Parliament, we are told, as an observer.

This week culminates with the G20 meeting in Moscow (Friday and Saturday) and for the first time Switzerland will take part, despite not being a member. While expectations are generally much more exuberant than the usually generic statement that is proffered by the G20 protagonists, this meeting will be acutely viewed by the foreign exchange markets for any hint or mention of currency wars.

Strong USD policy?
As the London trading session gets underway, the USD appears to have gained the upper hand, particularly with reference to JPY and GBP. Last week’s sentiment surrounding the JPY was one of concern for a reversal in fortunes ahead of the G20 meeting. The super cynical may perhaps suggest that comments from Finance Minister Taro Aso, that the pace of the JPY decline had been unexpected, were intended to lay grounds to the argument (at G20) that the JPY decline is an unintended consequence of an aggressive policy of inflation, generation intended to boost demand and returning the economy to growth. In my view it is unlikely that there is any form of reprimand for the Japanese at this stage and ultimately this is likely a continued green light for yen depreciation.

UK gets a pounding?
In the UK, the situation is perhaps not so positive on the policy front, with a lack of clarity surrounding a number of core policies as well as the UK’s position within and relationship with the rest of the EU going forward. Last week saw a number of ‘big ticket’ trades going through in GBP, and while this is a positive for the UK going forward in terms of trade flows, the rise in volatility makes assessing value and opportunity more difficult. This morning already it appears that there has been some continuation of ‘big ticket’ interest in GBP (seemingly to sell the pound) and as the week progresses inflation data for January, and the latest Quarterly Inflation Report (QIR) will likely keep GBP volatility elevated.

Overall I continue to favour the USD over EUR and JPY and while for GBP I see the weakness as a more temporary phenomenon, flows and sentiment will likely continue to underperform at the start of the week. Mr Draghi’s rhetoric in relation to the implications of the LTRO repayments has taken some of the pressure off of short dated Eurozone rates and since the press conference an effective 10 basis points of tightening has come out. This has in part, along with the more sanguine inflation outlook within the Eurozone taken the shine off the EUR. Along with GBP (in the very short term) I would expect the EUR to continue to underperform.