Weekly Review and Outlook: Euro Strength, Yen Weakness Dominated, More to Come?

Euro's rally and yen's decline dominated the markets last week. The common currency was lifted as Greece finally secured the second bailout. Also, markets have been bidding up Euro ahead of this week's send long term LTRO from ECB. Meanwhile, the Japanese yen's fall accelerated on BoJ QE expectations as well as strength in crude oil. Markets were rather dull elsewhere though, as dollar was bounded in range against sterling and commodity currencies. Momentum in stock markets was unconvincing as DOW struggled to close above 13000 level. However, commodities have been impressively strong as CRB index gapped above 319 resistance and has never looked back since then. Crude oil also managed to extend recent rise and accelerated to close close to 110. Technically, the sustainability of Euro's rally is not confirmed yet but yen's reversal looks real. We'd expect more selloff in the Japanese in near term but would be cautious on sign of loss of momentum in common currency.

EU finance ministers eventually approved the second Greek bailout package. The deal requires Greece to bring its debt down to 120.5% of GDP by 2020 from over 164% currently. The agreed reduction was similar to what was requested by the IMF. Moreover, according to Jean-Claude Juncker, the prime minister of Luxembourg, private sector bondholders were expected to incur losses of 53.5% of nominal face value of their Greek bond holdings, up from the previously expected 50.0% nominal write-down. The interest that Greece needs to pay for the first bailout package was lowered to 1.5% over market rates from 2-3% about market rates previously agreed. Moreover, the ECB and the 17 central banks in the Eurozone also agreed to forego profits on their Greek debt holdings. These measures aim to 'further improve the sustainability of Greece's public debt'.

Following the approval, Greece launched the private sector bond swap offer on Friday and the program targets to write-down as much as EUR 100b off it's debt. The Greek Finance Ministry noted that at least 90% of the aggregate face amount of all bonds is needed to participate in the PSI. If the participation is between 75% and 90%, Greece might activate the collective-action clauses and that might in turn trigger CDS. Greece will determine whether the take-up rate from investors is enough for the debt deal to proceed by March 9 while actual swap will take place on March 12. IIF managing director Dallara said he's "quit optimistic" on a high take up among bondholders. But all eyes will be on market responses in the next two weeks.

Also support Euro last week was the anticipation and speculations ahead of this week's second LTRO from ECB. In the first operation in December, over 500 banks tapped EUR 489b in three year cheap loans from ECB. There have been expectation that this time, banks might get as much as EUR 1T, but such overshoot expectations then scaled back to around EUR 500b level. The impact to the market is a bit tricky. Some economists said that if the take up is smaller than expected, the impact would be short term bullish and medium term bearish in Euro. On the other hand, if the take up is larger than expected, the impact would be short term bearish and medium term bullish in Euro.

Yen's selloff was another major theme last week. Yen weakness started earlier this month after BoJ announced a clear 1% inflation goal. The target is seen as paving the way to more aggressive quantitative easing from the bank. So far, BoJ lagged behind Fed and ECB in expanding their balance sheets since 2008 finance crisis. Thus, in spite of BoJ's various effort including intervention, it failed to halt yen's up trend. However, the situation could now be different as there is a clear inflation target. Moreover, based on current inflation outlook. BoJ indeed has more scope to expand quantitative easing then any other major central banks. It's speculated that BoJ's QE program could top as much as JPY 100T in 2012.

As discussed during the week, crude oil's rally was seen as another factors in yen's selloff. Japan posted record trade deficit in January, with steep fall in exports to China. Meanwhile, as an oil import country and an export led economy, Japan is facing additional pressure from recent rally in oil prices. After, last year's natural disaster in Japan, only 5 out of 54 nuclear reactors are staying in operation and thus increasing the demand for energy imports. This, coupled by strength in oil prices, will likely worsen the trade balance of the country.

Elsewhere, BOE minutes for the February meeting unveiled that 2 (Adam Posen and David Miles) out of 9 members opted for more expansion in asset purchases than decided. The 2 dissenters to the current monetary policy saw a risk of a prolonged period of depressed demand which would cause inflation to fall materially below target in the medium-term. Also, the expected that further easing would alleviate the risks of increasing unemployment. The news raised speculations that the central may increase the amount of asset buying in May. More in BOE Minutes Unveiled 2 Member Favored More Asset Purchases.

The RBA released minutes for the February meeting, explaining reasons for its decision to leave the policy rate unchanged at 4.25%, instead of a reduction of -25 bps as expected by the market. The central banks appeared comfortable with the domestic economic developments though these might also be affected by the sovereign debt crisis in the Eurozone. It appears that the central bank will stand on the sideline in coming months but we are still of the view that a rate cut will materialize later this year especially if he AUD continues its recent advance. More in RBA Feels Comfortable With Current Monetary Stance As Growth Will Be Close To Trend.