Money in Motion

Busch: Currency Markets Perceptions and Great Expectations

With the Greece parliament passingthe new austerity measures, the foreign exchange markets are buying risk with AUD,NZDand ZAR the top performers. The US dollar is down against 15 of the 17 major currencies . The EUR rallied from 1.3180 to 1.3280 on the Greek news and the comments from Chinese Premier Wen Jiabao saying that they would “fine tune” their economy starting this quarter.

The EUR has rallied from the lows in January as the ECB’s Long Term Refinancing Operation (LTRO) program stabilized funding for the European banking system. This has cascaded over to sovereign debt funding with Italian and Spanish spreads narrowing to German debt. All of this has greatly reduced the risk for a meltdown of the entire financial system in Europe.

My call for the beginning for the year was for a 7.5% drop in the EUR for the first half. Initially, we got half of that as the EUR/USD dropped from 1.3075 to 1.2640. However with no European meltdown, we’ve seen the currency melt up rather quickly from 1.2640 to 1.3240. Aiding this move higher, the market has gotten progressively short EUR/USD with a record short two weeks ago at -171k. Last week, EUR shorts were cut to 140k vs. 157k the previous week as the EUR moved up and traders cut back. Without further reduction in EUR/USD shorts, the FX market will not be able to significantly push the currency down.

Market implication: The EUR/USD should hold value between 1.30-1.34 even with Greek uncertainty and I do expect this dance for the 130 billion EUR to go all the way to the end of March. All Risk-On has benefitted as the market has gone farther out the risk curve buying HY CCC’s, US small cap and sovereign CDS. Remember, equities can still rally despite weak earnings and weak economic growth if there is no European cataclysm.

Why? As I stated in my 2012 central thesis, policy makers will act. The central banks across the globe are cutting interest rates or engaging in quantitative easing. For equities, a tight fiscal policy and loose monetary policy is constructive if the fiscal is not extreme. For 2012, this will be the case for the US and for Europe if the ECB continues to cut rates/expand balance sheet. We know that on 2/29 there will be another round of LTROs and the take-up should be large. This means the appetite for risk will continue through Q1.

Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a contributor to CNBC's Money in Motion Currency Trading.

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