With the Eur curve set to steepen even further due to the domestic demand imploding, ECB will have to play catch up in order not to remain way behind the curve. We have, amongst other central bank meeting this week, the ECB one, which will be the focus. As mentioned on the 9 Jan, I expect the ECB to cut rates to 1% before long. Any sign of turnaround in the ECB stance this week will hit the Eur hard.
Increasing loss of investor confidence will also weaken the Eur as the tensions within the Euro area increases. The PIGS countries bonds spreads vs the German one is becoming unsustainable. If the PIGs countries were Emerging Market countries the IMF would have told them off. (At least the old IMF). The new one seems completely lost, see Latvia as the most recent extreme example of negligence.
The Eur yield curve steepening mentioned above is a very interesting variable.
The 2/10 Year Eur yield curve steepening over the last couple of weeks has not matched the historical correlation with Eur/Jpy. In fact, there was a complete correlation break up in December. I do NOT expect this to last.
The Eur surge in December was mainly stemming from European (German) banks repatriating assets from abroad for year end purposes and after the German government rejected a suggestion to start a "Bad asset bank" in order to clean out the banking sector.
Yes, the German government took a 25% stake in Commerzbank. This means they will become a more Euro and German oriented bank, from a strategic point of view, leading to repatriation of assets from abroad. On the other hand, the German government recently did a 180 degree turnaround as they indicated they would be more open to a "Bad asset bank" idea, and as they are looking to support further corporates under siege, decreasing the need for German corporate asset repatriation in the process
The Japanese lifers
Japan´s portfolio of net foreign assets is about 3 Trn Usd, of which 2Trn Usd is privately held, the rest is BOJ and MOF. The private holdings have partly diversified away from the Usd, with 35% of assets held in Eur. Lion part of the privately held assets are with Japanese Lifers.
These have and are still acting quite mechanically when it comes to hedging patterns; No currencyhedging as yieldcurves are inverted and vice versa as curves are positive. This in order not to hedge away the increased yield in their foreign investments.
With the Euro 2/10 year yield spread at about 160-170BP, it has increased the Lifers attention to currency hedging again.
Since Japanese lifers have committed themselves to deliver 2% yield annual returns and with the Euro yieldcurve to steepen further nearterm. A spread of 2% on the 2/10 Yr Euro curve would attract significant amount of currency hedging flows, strengthening the Jpy in the process. With the 10 Year JGB at 1.35% ish yield, expect a strong interest for currencyhedging from Japane lifers, with interest to increase as the Euro curve steepens further.
The US and the credit spread focus
As I mentioned in December in my Usd piece, the US authorities commitment and focus on the credit spreads will become a strong positive driver for the USD as well. Please read that piece for reference since it is still valid.
As always, good luck
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