Dollar Ended The Week Higher On Debt Ceiling, BOJ In Focus

There are some important points to note about last week's market developments. Firstly, it's a surprise that dollar ended the week as the strongest currency, gained against all other major currencies. The news that GOP agreed to lift the debt limit for three months gave the greenback a late boost before the week ended. Secondly, risk appetite continued to drive stock markets last week and sent S&P 500 and FTSE 100 to five-year highs. But the risk sentiments were not seen in commodity currencies.

Instead, a steep sell-off was seen in the Canadian dollar against the US dollar before the weekend on the above news. Thirdly, the euro remained strong against other European majors and in particular against Swiss franc. Key medium-term resistance level in EUR/CHF was taken out as funds continued to flow back to the eurozone. However, against the dollar, the euro struggled to extend recent gains.

Fourthly while yen's downtrend continued last week, it has lost some momentum ahead of this week's BoJ meeting. Fifthly, Sterling was indeed the second weakest currency, just slightly better than the Swiss franc and has indeed closed lower against yen.

Looking ahead, yen weakness is still expected but there could be some notable rebound if BoJ disappoints markets this week. By disappointing, we mean BoJ delivering what have been priced in, that is, a modest expansion of the stimulus and a doubling of the inflation target to 2%.

European majors were mixed as sterling was rather weak while the euro has been resilient. A short-term top formed in EUR/CHF already and we'd probably see some sideway trading this week. EUR/GBP though, has accelerated recent rally. However, note that GBP/USD would face near-term support at 1.5827 this week and we might see a rebound. Meanwhile, the news on the debt ceiling would likely give the dollar an extended boost in the early part of the week.

While Canadian dollar was relatively weaker, the aussie could catch up any time should the dollar continue to pick up strength. Overall, we'd think it a bit risky to add to yen shorts in the early part of the week. Even though the Europeans could be softer against dollar, we'd tend not to short them. Our preference would be on long USD/CAD and to a lesser extend short AUD/USD this week. And another choice would be going long in EUR/GBP.

In the US, it's reported that after a close door negotiation, House Republicans agreed to raise the so called debt ceiling for three months. The deal was under a condition that both House and Senate would pass a budget within the the time to clear the way for long-term deficit reduction negotiations. Nonetheless, that's a move that would significantly reduce the threat of US government default in the coming weeks.

The Fed's Beige Book covering the period from November 14 to January 4 indicated that economic activity in all 12 districts showed 'either modest or modest' expansion. The tone of this report was more positive than previous ones. More importantly, it suggested that recovery in the housing market is underway and this would in turns lift the prospect of other sector in the economy.

News out of Europe was mixed. Successful Spanish bond auction add further confidence to stability in the eurozone. And such confidence in a main driver in reverse safe haven flow from the Swiss franc back to the euro, which was clearly reflected in recent strength in EUR/CHF, as well as EUR/GBP. However, the euro hit some resistance towards the end of the week as IMF said that Greece, the center of the eurozone debt crisis, would face a financing gap of EUR 5.5b to 9.5b for 2015 and 2016. Also, there were concerns on the eurozone's economy itself, in particular after Germany reported overall annual growth was pushed further down to a mere 0.7%, comparing to 3% in 2011 and 4.2% in 2010.

The ECB said in it's monthly bulletin that "more recently several conjunctural indicators have broadly stabilized, albeit at low levels, and financial market confidence has improved significantly." And, "later in 2013 a gradual recovery should start." It also noted that the "accommodative monetary policy stance, together with significantly improved financial-market confidence and reduced fragmentation, should work its way through to the economy, and global demand should strengthen." Also ECB urged that “further structural reforms should be rapidly implemented to make the euro area a more flexible, dynamic and competitive economy."

Talking about EUR/CHF, it should be noted that the current weakness in the Swiss franc might prompt SNB to reverse some of its euro purchases for protecting the 1.2 floor to lock in profits. Or at least, SNB might make use of the opportunity to diversify its reserves. We don't expect that to reverse the EUR/CHF near-term uptrend. But if that happens, EUR/CHF's upside momentum might be dampened a bit and there could even be some brief retreats. It's generally believed that, though, SNB would raise the EUR/CHF floor as it doesn't need to.

In the UK, BoE governor King said to a parliament committee that "it is at a point where the economy is operating well below full capacity, the banking system is in a stretched position and we are clearly struggling to find instruments to ensure an economic recovery." King also noted that "the main problem of the euro crisis is the ability to find a way of financing current account and trade deficits." And, the so called banking union could just enable "countries which have banking systems that need to be recapitalized to have that recapitalization financed by other members of the euro area."

Meanwhile, King also said while the ECB calmed markets, it can't "resolve the underlying real challenges of either moving to a transfer union or finding a way to take sufficiently effective measures to change the competitiveness of the member countries of the euro area" and banking union isn't the answer neither. A prepared speech of Prime Minister Cameron raised the "danger" that the EU will fail and the UK would "drift towards the exit," Cameron intended to set out a "positive" vision for EU's future where the UK would play a "committed and active part." But he also warned that the EU was undergoing "fundamental change" and there is " a lack of democratic accountability and consent" that is "felt particularly acutely in Britain."

The BoJ meeting will be the major focus this week. There were a lot of official comments about yen last week. But what matters most is what BoJ would actually do. Markets are expecting additional stimulus and the doubling of the inflation target to Abe's 2% level. Also, the government and BoJ will issue a joint statement after the meeting. It should be noted again that markets should have priced in these expectations already.

Additionally, the BoJ would need to do something strong to impress the markets for giving additional fuel for a rally in yen crosses. That means moves like open-ended asset purchases or removal of the 0.1% deposit rate. Otherwise, we might see an after the news pullback in yen crosses this week.

The Australian dollar was weighed down by weaker than expected job data. The job market contracted by -5.5k in December comparing to expectation of 4.5k growth. The data series has been rather volatile with a pattern to oscillate from month to month between upbeat and downbeat. But even though November's upbeat data was revised further up from 13.9k to 17.1k, the two month combined total was disappointing due to December's contract.

The unemployment rate also rose to 5.4% as expected. Recently released forward-looking ANZ job advertisements dropped for a tenth straight month in December, raising the concern that job markets will remain weak down under. Unemployment could actually surpass RBA's projection of around 5.5% by mid year and prompt further rate cut from the central bank.

Chinese Q4 GDP rose 7.9% qoq versus expectation of 7.8% qoq. Also, that's an improvement over Q3's 7.4% qoq and was the first pickup in two years. The data is seen as a sign of strength that would carry on into Q1 and Q2 this year.

The World Bank sharply lowered its 2013 global growth forecast to 2.4%, comparing to prior projection of 3.0%. That's just a slight improvement from 2.4% in 2012. The World bank noted that global recovery is expected to be "closer to the end of the first quarter and into the second quarter of 2013, rather than beginning a little earlier."

It warned that the "global economic environment remains fragile and prone to further disappointment" even though risks are less skewed to the downside now. And, it noted that policy uncertainty in US has already dampened growth and warned that Should policymakers fail to agree such measures, a loss of confidence in the currency and an overall increase in market tensions could reduce U.S. and global growth by 2.3 and 1.4 percent respectively."

For advanced economies, growth is expected to be very weak at 1.3% in 2013 as weighed down by austerity, high unemployment and sentiments. That's a sharp downward revision from June's forecast of 1.9%. Growth is then expected to recover slightly to 2% in 2014 and 2.3% in 2015.

The US is expected to grow 1.9% in 2013, the eurozone to contract -0.1%, Japan to grow at 1.5%. For developing countries, growth is expected to be the slowest in a decade at 5.5% in 2013, also revised down from June's projection of 5.9%. Growth is then expected to pick up to 5.7% in 2014 and 5.8% in 2015. China's growth is expected to rise to 8.4% in 2013 then slow to 7.9% by 2015.