Morning FX thoughts - 21 Dec '11

Westpac Global Markets Strategy Group

Wednesday 21st December 2011

Risk assets surged overnight on the back of a solid Spanish debt auction and a stronger than expected German December IFO business survey.

EUR initially jumped from just above 1.3000 to 1.3040+ after the results of Spain's short term bill auction showed strong investor interest. The stronger than expected German IFO survey then saw EUR put on another 40 ticks in quick time while the arrival of NY scene saw a final lunge from around 1.3080 to session highs around 1.3132.

A much stronger than expected US housing starts report added yet more fuel to the risk rally. The strong demand for Spanish debt comes ahead of the allotment of unlimited 3yr liquidity through the ECB's LTRO program tomorrow. There is a strong suspicion that the outsized demand for peripheral EU bonds in recent sessions reflects a grab for collateral ahead of the ECB liquidity auction.

AUD rose from 0.9950 in early European dealings and hit a session high of 1.0095, outperforming EUR despite the dovish tone to the RBA's minutes released earlier in Asian trading.

The NZD rose from around 0.7620 to session highs just shy of 0.7720 amid the surge in risk appetite.

The Dow Jones surged 330pts overnight, or +2.8% while US Treasury yields rose 11bp to 1.92%. Copper rose 2.1%, while gold added $21.50 to finish NY trading at $1615.80.

US housing starts rose 9.3% in Nov. Most of this jump was in the volatile multiples component, up 25.3%, although back to back rises averaging 3% in single family starts in the first two months of Q4 have now almost reversed the declines seen right through Q3. House permits rose 5.8% also supported by multiples (up 14%) although single family permits also rose for a second month, by 1.6%. This is a positive report backing the less weak message from the recent homebuilder confidence upswing and rising sales, but the level of activity remains so low that any contribution to near-term economic growth from the sector will remain minor even if these gains are sustained in coming months.

The German Ifo business climate index rose from 106.6 to 107.2 in Dec. The second monthly gain in this survey of 7000 German businesses reflected steady current conditions (no rise since June) but a further modest recovery in expectations after eight falls in a row. This suggests that the economy has not fallen off a cliff in Q4, although we still expect growth to have stalled.

Elsewhere, Sweden's Riksbank cuts rates 25bp from 2.0% to 1.75%, after seven successive rate hikes between mid 2010 and September this year.

AUD/USD and NZD/USD outlook next 24 hours: NZ's Q3 current account is due later this morning along with migration data and credit card spending for Nov. Westpac looks for the current account to come in slightly wider than consensus at 4.0% of GDP. The October Westpac leading index for Australia is due in local trading as well.

US existing home sales are on tap tonight but the key event is the allotment of the ECB's 3 year liquidity tender for banks. Expectations are for banks to take anywhere from EUR200-550bn in 3yr liquidity. A high figure may not necessarily reflect stress in the Eurozone banking system (as pervasive as it is). Rather, banks may look to take the funds and use it to pay down their debt, boost their liquidity ratios and even possibly engage in a carry trade by purchasing high yielding peripheral bonds.

AUD/USD and NZD/USD should hold into their overnight gains into the ECB LTRO. NZD should run into demand into 0.7660/70 while AUD should find bidders into 1.0030/40.

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