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The euro tested the water below the 1.30 level yesterday and also at the start of the European session this morning.   EUR/AUD, our favoured cross over recent weeks, fell back to 1.2450 at one stage; on Monday, it reached a 3mth high of 1.2580.

Suddenly, some of the old worries about the eurozone seemed to re-surface. For instance, Germany remains attracted to the idea that the ECB should only supervise and be responsible for Europe’s largest systemically important banks, whereas Brussels prefers giving the ECB the task for monitoring all of Europe’s banks irrespective of size.

Guest post by Forex Broker FxPro

The selling was reasonably broadly-based. In contrast, the dollar’s fortunes improved for a time (see below), although it did lose out to the Japanese yen. Another development being watched closely is the oil price – Brent crude has fallen by almost USD 10 since the Fed announced a week ago that it was cranking up the printing presses again.


More fuel for the China slowdown story.   One of the reasons for the slightly better tone to the US dollar so far this week has been the continued focus on China, both with respect to the slowing economy and also growing tension with Japan.   The initial HSBC manufacturing survey for September suggested that the outlook remains more fragile, the index standing at 47.8 (which in theory is contractionary territory). Whilst there are other factors at play, the more cautious tone has seen a sharp down-move in AUD/JPY, the biggest one-day decline for two months.

The BoJ can’t compete. The yen finds itself some 0.6% firmer vs. the dollar since yesterday’s surprise announcement of further quantitative easing measures, which underlines just what a tough task the central bank has in keeping its currency down. If we take the change in the central bank-balance sheet from mid-2008 to mid-2012 as a proxy for stimulatory measures, the increase in the Bank of Japan’s balance sheet has been modest in comparison with its international counterparts. The increase in the BoJ balance sheet represents 7% of GDP, which is around half that of both the UK and the ECB over the same period. Both the UK and eurozone saw their currencies depreciate over this period – by around 11% and 16% – respectively using a basket of currencies, whereas the yen has increased nearly 50% during the same period. Now, we can’t ascribe these differences just to the change in central bank balance sheets seen over this time. There have been a host of other factors in play during the period. Furthermore, on the same basis, the dollar has risen around 14% during this period on a 12% increase in the Fed balance sheet (compared to mid-2012 GDP). There are two further points to bear in mind before we think about currency conclusions.   Firstly, Japan comfortably represents the fact that it’s the change in the central bank-balance sheet that matters more, rather than the size. The BoJ’s balance sheet is still the largest of the major central banks, representing over 30% of the economy. Secondly, Japan remains the world’s strongest creditor nation, holding far more in overseas assets than foreigners hold of Japanese assets and this ensures a strong and on-going demand for yen from interest and dividend-repatriation flows. But what remains key and likely to frustrate the Japanese authorities is that the Fed has left its latest QE program open-ended, promising to buy securities month after month until the economy shows sufficient improvement (but leaving ‘sufficient improvement’ undefined).  The dollar reaction was telling, initially falling even further after the announcement with this coming after declines in the previous three weeks. This has shown that currencies are becoming more sensitive to renewed quantitative easing measures but, although the BoJ move was not fully anticipated, the Fed has played a stronger hand and that is going to continue to add downward pressure on USD/JPY.

Dollar bears must tread warily. Of interest since helicopter Ben’s announcement last week that he would keep the printing presses running both night and day is that the dollar has actually increased slightly. This follows roughly a 5% decline in the dollar trade-weighted index over the previous two months as speculation intensified that more Fed QE was coming and that the ECB was preparing an asset purchase program of its own. Many commentators are of the view that infinitesimal quantitative easing from the Fed will continue to weigh on the dollar in coming months. For a start, the sense of crisis in Europe which cast such a long dark cloud over the single currency in the first half of the year has lifted somewhat, resulting quite recently in a capitulation by those traders and investors who were structurally short the euro. It could very well be the case that there is more of this type of short-covering activity to come – for example traders are still significantly short the single currency, although not as extreme as they were mid-year. Those who contend that the dollar is headed still lower are also invariably transfixed by the fiscal cliff and the potential damage it could wreak on the economy unless Congress can dilute its impact by some minor miracle. Like Moody’s, dollar bears are very worried by the monumental liability stream which will confront the American government in coming years. In addition, with the Fed essentially committing to zero rates until 2015, the dollar’s attraction as a funding currency has increased still further. However, dollar bears needs to tread warily as there are some warning signs against becoming overly negative. From a technical standpoint, the dollar is oversold and could already be in the process of reversing some of the recent losses. Politically, it appears that President Obama will be re-elected following some major gaffes by Mitt Romney recently – continuity in the White House probably increases the chances of the fiscal cliff being watered down. Also, America’s banks retain a healthier capitalisation than most of their European counterparts and the dollar is quite competitive. In the near term, it might be wise for traders not to get sucked into a vortex of dollar negativity. It has been a good time for dollar shorts over the past two months, but in the near future the USD’s direction is likely to be much murkier and harder to trade.