Market Rumours

It's no coincidence that during the period when the BOJ introduced yet another liquidity facility and the RBA hiked rates for the third time, long AUD/JPY positions held by Japanese retail traders reached new record levels, says Citi. The bank adds ongoing interest rate divergence and Nikkei underperformance are likely to reignite capital outflows from Japan and over time the JPY will once again wrestle the title of the world's funding currency away for the dollar.

There is no need for the European Central Bank to start an interest rate-tightening cycle, ECB Governing Council member Guy Quaden said Monday, citing subdued inflationary pressures. The ECB last week held its key rate at 1.0%, the same rate it has maintained since May following a series of sharp cuts. Since the financial crisis intensified last year, the ECB has also injected unprecedented amounts of liquidity into the banking sector to help spur lending. It hinted last week that this stimulus will be unwound gradually, but didn't provide a timetable. There were signs that some ECB board members disagreed about when to withdraw this liquidity support. Quaden, who is also governor of the Belgian central bank, told a news conference in Brussels that the ECB's exit strategy is "not pre-defined." "Let's wait a bit, because right now we have forecasts that are still, by definition, uncertain. We will wait for more information in the months to come," Quaden said. Quaden said he expects relatively positive economic growth in the euro zone and in Belgium during the fourth quarter of this year and the beginning of 2010. He warned, however that this outlook is uncertain, particularly if the euro continues to climb against the dollar. "If the exchange rate were to rise significantly, this would not be helpful for economic growth in Europe," he said. The euro currently is hovering close to $1.50, a level European business groups have described as "very painful." As the euro rises relative to other currencies, its exports become less attractive on foreign markets, slowing a key source of the region's economic activity.

Friday's generally upbeat U.S. non-farm payrolls report is unlikely to discourage investors from using the dollar to fund risky bets in higher-yielding assets. Investors, spurred by near-zero U.S. interest rates and easy availability of funds, have borrowed huge sums of money in U.S. dollars in recent months to purchase assets overseas where returns are higher, But some traders said the jobs data forced many market participants to cover short dollar positions on Friday, which may signal the end of trades that blindly sell the dollar on strong economic news in carry transactions. The dollar gained against major currencies on Friday, pushing the greenback to its best performance against the euro since June.Hover, Most analysts and fund managers said the dollar's gains could be short-lived and the trend using the dollar to finance carry trades is not about to change. The use of the dollar as a funding currency has undermined the greenback, which has fallen roughly 7.0 percent so far this year against a basket of currencies .DXY. "It's premature to conclude that the dollar bear market has ended," said Paresh Upadhyaya, senior portfolio manager, at Putnam Investments in Boston. Upadhyaya helps oversee assets of about $20 billion (12 billion pounds). He added that the improvement in the labor market was long overdue because leading indicators such as jobless claims have been on a downward trend anyway for the last several months. It was therefore only a matter of time before this translates into slower job losses.For instance, China said on Friday it would look to diversify its huge foreign exchange reserves across currencies and high quality assets, although the dollar would remain the anchor currency. It also doesn't help the dollar's cause that other foreign assets are a lot more attractive. "We do see a lot of capital outflows from the U.S. private sector," Englander said, and that is not going to change. Concerns about record fiscal deficits, resulting from the United States borrowing hundreds of billions of dollars to resuscitate an economy ravaged by the global financial crisis, have further weakened demand for U.S. assets, making it likely the dollar will weaken further.

Japan's Nikkei stock average climbed 1.5 percent to a six-week closing high on Monday, with exporters boosted by the dollar's surge against the yen late last week after better-than-expected U.S. jobs data fanned recovery hopes. Japan Airlines Corp gained 7 percent after a government source said it is considering guaranteeing about 700 billion yen ($7.8 billion) in loans and other funds for the debt-laden airline.

The top share index fell 1.0 percent on Monday, pressured by weaker banks on windfall tax concerns, and with miners and energy stocks also weighing, hurt by falls in commodities prices. At 9:10 a.m., the FTSE 100 .FTSE was down 55.56 points at 5,266.80, having closed up 9.36 points on Friday at 5,322.36 after U.S. employers cut a fewer-than-expected 11,000 jobs in November, the smallest decline since the start of the recession in December 2007. Banks were in the doldrums after news that Britain was still considering some kind of windfall tax on bankers' bonuses. Barclays (BARC.L), HSBC (HSBA.L), Lloyds Banking Group (LLOY.L), Royal Bank of Scotland (RBS.L) and Standard Chartered (STAN.L) shed 0.7 to 1.8 percent.

Japan is looking at guaranteeing about $7.8 billion (4.7 billion pounds) in funding to Japan Airlines Corp (9205.T), a government source said on Monday, easing concerns that the carrier could run out of funds and helping send its shares 7 percent higher. The 700 billion yen in guarantees would be included in an extra budget expected to be compiled this week and may cover investments and loans, the source said, speaking on condition of anonymity. Debt-laden JAL, which is seeking its fourth state bailout since 2001, has warned it could face bankruptcy unless it addresses a pension shortfall of about 330 billion yen. But a state-backed turnaround body will not be making a decision on whether to inject public funds into JAL until January. "The news eased worries that a shortage of operating funds ahead of the year-end might force JAL to stop flying," said Mizuho Investors' Securities senior analyst Takahiko Kishi.

The dollar has pushed broadly higher in European trading, extending the gains it made Friday after a stronger-than-expected employment reading, pushing the euro under $1.48 for the first time in a month. Sterling is also lower, trading below $1.64. The buck is also higher against Canadian, Australian and New Zealand dollars. However, further gains against the yen are proving tough to make. Exporter selling in USD/JPY is offering a near-term barrier around Y90, where the dollar is now trading.

Nomura Securities forecasts USD/JPY to fall through end-March, to 83.00. As result of stronger JPY, expects BOJ policy to focus on reducing market interest rates from end-calendar 2009 via quantitative easing, as seen from 2001-2003; "any such move, in our view, would help hold long-term interest rates at a low level and ease the upward pressure on the yen." For medium term, projects low interest rates to provide annualized boost of 0.2 percentage point to real GDP growth over 2 years, assuming long-term market interest rates decline 0.5 percentage point, with capex having largest positive impact of all demand categories. If successful, says resulting weaker JPY would likely lift real GDP growth by 0.3 percentage point, (assuming 10% JPY fall), with general machinery/real estate benefiting most from lower capex costs/lower debt costs, respectively. Adds BOJ policy impact to vary significantly between sectors.

Concerns that the USD funded carry trade is about to unwind is a little premature, says IG Markets strategist Ben Potter. "While the U.S. dollar may benefit from a technical bounce in the coming weeks and on the basis that futures markets are pricing in a chance of rates moving by mid year, investors should remember that the interest rate equation is a relative one," says Potter. Notes Australia is expected to have several more interest rate hikes by mid-2010 and that if the U.S. raises interest rates, many other economies would also be likely to do so. "If that were the case, the unwinding of the carry trade would likely be orderly rather than precipitous," says Potter.

USD/JPY may edge higher this week if comments from Fed chairman Bernanke, scheduled to speak at 1745 GMT, fuel speculation bank to raise interest rates sooner rather than later, following better-than-expected non-farm payrolls for November Friday, says Barclays Capital FX strategist Yuki Sakasai. Says attention also on U.S. retail sales for November on Friday; "If (Bernanke's) economic perception becomes more optimistic, and if the indicators turn out well, there is a risk the dollar could strengthen more." November retail, food sales tipped up 0.7% vs 1.4% rise in October. USD/JPY last 90.02.

USD/JPY gains could be capped this week if U.S. interest rates rise for "wrong reasons" amid string of U.S. Treasury auctions, says Yuji Saito, head of FX group at Societe Generale. "If demand is weak at the auctions, you could have a situation where interest rates go up but U.S. stocks aren't rising that much, like on Friday (DJIA +0.2%)." Says such "bad interest rate rises," as compared to more USD-supportive "good" rate rises, which would come with rallying equities, could weigh on pair by focusing attention on U.S. budget, debt issuance concerns. USD/JPY last 89.99; says likely in 89.50-90.50 range for day. U.S. Treasury to sell $40 billion in 3-year notes Tuesday, $21 billion more of last month's 10-year notes Wednesday, $13 billion of last month's 30-year bonds Thursday.

Volatilities implied by 1-month ATM USD/JPY options up at 12.40%/13.10% from 11.95%/12.65% Friday in New York; sharp rise in USD Friday on better-than-expected non-farm payrolls report for November, just one week after unit plunged to lowest level vs JPY in 14 years, encouraged some players to seek hedges against further swings; one player buys 3-month ATM straddle contract with implied volatility of 13.55%, face value of around $100 million; another enters 1-year ATM straddle with implied volatility of 14.60%, face value around $200 million, says options dealer at major Japanese bank. But adds spot, hovering around 90.00 Monday, could remain calmer this week with few major trading cues, possibly pushing middle-price of benchmark options down to 12.00%.

Kuwait's sovereign wealth fund said on Sunday it had sold its stake in U.S. bank Citigroup (C.N), becoming the latest Gulf investor to sell foreign shares as markets improve. Kuwait Investment Authority (KIA) transferred the preferred stocks it owned in Citigroup to normal stocks and sold all of them for $4.1 billion, KIA said in a statement. KIA said it made a profit of $1.1 billion from the sale, or a 37 percent return on its initial investment. "Kuwait Investment Authority had invested an amount of $3 billion in Citigroup in the form of preferred stocks in January 2008," KIA said. It did not disclose the number of shares it had sold or what it planned to do with proceeds from the sale.