Japan & China - Deepening Financial Ties

Over Christmas, Japan and China have deepened their financial ties, announcing plans on a currency pact on Sunday. Specifically, Tokyo and Beijing have agreed to increase direct yuan-yen trade, instead of converting their currencies to dollars first, and also for Japan to hold yuan in its foreign-exchange reserves, which are currently predominantly denominated in USD. The move is in line with China’s ambitions to seek a bigger role for the yuan globally, which in turn could lead the country to open up its financial markets further and reduce the amount of FX intervention. From that perspective, it may be welcomed by the US, as it would reduce the amount of Chinese FX interventions and make the yuan exchange rate more flexible. While the immediate effects of the pact are largely symbolic, a further diversification away from USD as the world’s preferred reserve currency should reinforce the structural trend for a weaker dollar, which we foresee will be a dominant theme on the FX market in 2012 (see FX Top Trades published on 14 December 2011). See Wall Street Journal for more details.

The Bank of Japan (BoJ) has published minutes of its 15-16 November meeting,
which revealed a “few” BoJ board members seeing increased downside risks to
growth from the European debt crisis and the appreciation of JPY. While the BoJ
refrained from altering policy at its latest monetary policy meeting, a further
appreciation of JPY is likely to see the Bank respond more forcefully in our view,
intervening further in the FX market and increasing its asset purchases. The BoJ also published minutes of a board meeting on 30 November, held ahead of the decision by global central banks to lower the rate on USD liquidity swaps.

It is generally risk off in Asian markets this morning, as investors seem to be
taking a cautious stance ahead of year-end. Furthermore, the fact that financial
markets are closed in Australia, New Zealand and Hong Kong is adding to the thin
liquidity. On the FX market, the price action has also been muted, with EUR/USD
still hovering above 1.30.

On Friday, US equities ended the week on a solid footing, with the key indices trading around 1% higher. The positive sentiment was helped by signs of a break in the latest congressional deadlock, as House Republicans agreed to extend the payroll tax cuts by two months. Global equity markets around the world were closed for Christmas holiday yesterday.

Global Daily

On the data front, today looks set to be very quiet. US consumer confidence is the
main release, we look for an unchanged reading of 56 (i.e. below the consensus
estimate of 58). Later this week, the Italian bond auction (Thursday) will be closely
followed. The auction will be in the three- and 10-year segments and we expect a
combined amount in the range EUR3-5bn.

There are no scheduled events in the Scandinavian markets today.