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VIX JUMPS HIGHER HIGHLIGHTING MARKET NERVOUSNESS Canadian retail sales is the only fundamental release expected.
-Market focus will shift to FOMC statement to be released on Wednesday.
-Rumours circle over the potential for the PBoC to rise interest rates on the weekend.
-As the VIX moves higher, carry trades come under pressure.

FX Market Update

Markets are changing rapidly as we go to print; however some currencies have managed to put in gains against the USD in the last 12-hours, with outperformance from AUD and EUR; underperformance by GBP and CAD essentially flat. Markets are nervous as the VIX jumped up to a one-month high and G7 currency vol has begun to move off its recent lows.
• This proved an important week and one that has had a significant impact on FX markets. The main developments were generally USD positive as they either increased the safe-haven bid of the USD or drove risk aversion. Accordingly the markets are left evaluating whether recent developments - outlined below - have already been priced into markets or whether there is more USD strength on the horizon. The key concerns are: 1) Increasing fears that China will soon tighten policy in an effort to cool the economy -- we still maintain that developments to date will actually prove a medium-term positive as they will decrease the risk that the market is faced with a surging Chinese asset bubble followed by the popping. However for now the market looks at tighter policy in China as negative for global growth and therefore commodity currencies. 2) Issues surrounding sovereign risk, the impact on the greater Eurozone of its weaker countries and how the ECB will implement policy over such a diverse set of countries. This has left sentiment towards the EUR at remarkably negative levels. 3) President’s Obama proposal on the size and scope of financial institutions. The release, which still leaves a lot of questions, immediately conjured up thoughts of position liquidation, worries over USD outflows and brought two-way risk back into the market. 4) The Republican win in Massachusetts, which has altered support for President’s Obama’s health reforms and will most likely have a positive impact on the US deficit. Accordingly, as we close this week we think it was one with important developments that could have ongoing near-term effects on markets.
• However, we also note that next week the market’s attention will turn to the FOMC meeting to be held on Wednesday January 27th. There is little debate that the FOMC will leave interest rates on hold; however focus will be on any changes to tone, the “extended period” language, or the emergency programs. • The DXY (USD index) hit its recent low on November 26th (74.17) and has since climbed 5.3%. Currency returns since then are noteworthy - see top chart - and highlight how the market has interpreted recent events. CAD has outperformed (gaining 1.0%), speaking to our view that CAD can still outperform in a period of USD strength. AUD has lost a mere 1.0% as the strong fundamentals have supported it. GBP has been a mid-performer, losing 2.2% as it has been supported by recent economic data releases. EUR has underperformed miserably losing 6.0%. C.S.

Americas

USDCAD (1.0500) • USDCAD has had a volatile early session and has retraced earlier losses to enter the North American session close to yesterday’s lows. So far it has not been able to break above the 100-day MA of 1.0568. Today’s close will be important for near-term traders, anything above 1.0514 would be near-term bullish. Outside of the very near-term, we continue to believe that USDCAD will move lower in the months ahead. • In yesterday’s MPR, the BoC reiterated much of what Governor Carney said on Tuesday. Including that the strength of CAD has dampened the outlook for growth and is a key risk to inflation going forward. The Bank has made slight adjustments to its growth outlook, but they continue to see final domestic demand playing an important role as net exports subtract from growth in 2010. C.S.

Europe

EURUSD (1.4130) • EUR has recovered from yesterday’s losses and has gained 0.3% against the USD as we move into the North American open. This is a positive sign; however there is a long way to climb before the technical outlook will turn bullish. Sentiment remains bearish against the EUR. Today’s release of CFTC speculative positioning data could prove interesting as it will shed some insight into whether EUR shorts are still building positions. • Industrial new orders came in stronger than expected, rising 1.6%m/m and dropping just -1.5%y/y. Next week the Eurozone will release important fundamental data, including unemployment, and CPI. C.S.
GBPUSD (1.6165) • GBP is essentially flat against the USD and has lost ground against the other primary currencies as we move into the North American open. • UK retail sales disappointed, coming in at just 0.3% m/m (cons. 1.1%) and 2.1% y/y. However, generally data releases this week have been positive for the GBP as inflation was higher than expected, unemployment dropped to 7.8% and public finances (which are still bleak) at least came in above expectations. Accordingly, netting out the noise, developments for GBP were more positive than for most other majors this week. We hold a 1.67 year-end forecast for GBP. C.S.
EURCHF (1.4705) • EURCHF has dropped noticeably away from the SNB’s previous line in the sand of 1.50, with very little reaction. Today it is recovering some of yesterday’s losses, but it remains well below levels we saw in early December. C.S.

Asia / Oceania

USDJPY (90.20) • USDJPY has broken through and is now flirting either side of both its 50-day moving average and 100-day (90.14 and 90.35, respectively). Also important was that today’s brief dip below 90 in USDJPY, was the first time we have seen this type of yen strength since Finance Minister’s Kan has been in power. Today he was quoted as saying that the government should not ask the BOJ to take specific policies but they are working together to support the economy. • Technically, the three-year USDJPY downtrend remains in tact and should continue to put downward pressure on USDJPY. A significant break below 90 will be important from both a fundamental and technical perspective. • As the VIX moves higher the carry trade could be pressured, which would cause some buying back of yen positions. • The BoJ will release its interest rate decision in the early part of the Asian session on Tuesday January 26th. C.S.
USDCNY (6.8269) • Rumours are circling widely in markets that the PBoC will raise interest rates this weekend. China has not tightened policy since December 2007. Though tighter policy will help to slow growth and avoid an acceleration of an asset bubble, it is difficult for China to have real control over its monetary policy while they peg their currency to the USD. • We continue to expect Chinese authorities to allow some measured appreciation of the yuan in the coming months. C.S.

Commodities

Oil (76.00) • Oil is testing its 100-day moving average of 75.22, a break below would be a technically bearish signal. The 30-day rolling correlation between CAD and oil is at 0.75. Further downward pressure on oil will most likely come in tandem with upside pressure on USDCAD. C.S.
Gold (1094.25) • Gold has had two difficult sessions, losing 3% and dropping from 1138.20 to 1094.25. The metal is currently testing its 100-day moving average of 1087.13, a break below would be bullish and most likely come in tandem with further USD gains. C.S.

Suggested Reading

The Great Piggy Bank of China, Samuel Brittan, FT (January 22, 2010) A Fearful Europe Trails Petulantly in US Wake, Philip Stephens, FT (January 22, 2010) New Bank Rules Sink Stocks, Jonathan Weisman, D. Paletta & R. Sidel, WSJ (January 22, 2010) Fed’s Bernanke Faces Tighter Vote in Senate, Sudeep Reddy & Damian Paletta, WSJ (January 22, 2010) China Targets Inflation as Economy Runs Hot, Terence Poon & Andrew Batson, WSJ (January 22, 2010) Investors Fret Over Obama’s Bank Assault, Jamie Chisholm, FT (January 22, 2010) Please consider voting for us in Euromoney's FX Poll 2010 between January 14 and February 26. The link can be found at http://www.euromoney.com/stub.aspx?stubid=92.
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Camilla Sutton, CFA, CMT Sacha Tihanyi
Currency Strategist Currency Strategist
Scotia Capital Scotia Capital
416-866-5470 416-862-3154
Camilla_sutton@scotiacapital.com Sacha_tihanyi@scotiacapital.com



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