Yen Dived On Easing Expectations, Post Election Reactions Watched

While dollar was sold off broadly on Fed's easing extension last week and fiscal cliff deadlock, yen was even weaker ahead of election on Sunday. BoJ is widely expected to expand its easing program this week but markets are already pricing in more aggressive easing next year, after the Liberal Democratic Party reclaims power. Rally in yen crosses have indeed reaccelerated. But we'll be cautious on initial post-election reactions this week to see if there would be any after-the-news profit taking.

Meanwhile, despite a brief intra-week rebound, dollar was back under pressure towards the end of the week and made new lows against other majors. Little progress was seen regarding the fiscal cliff negotiation and the greenback's fall could gain momentum as markets getting thinner ahead of year-end holidays.

So overall, selling yen and dollar are preferred this week with yen selling as first priority. Nonetheless, if the yen does manage to get a post-election recovery, preference would be shifted to dollar selling. Lack of momentum in US stocks and commodities, due to fiscal cliff uncertainties, would keep rally in Aussie and Canadian dollar limited. Among the European majors, the euro is having an upper hand against sterling for the moment. And after SNB meeting, EUR/CHF could now spiral back towards 1.2 psychological level. And that means Swiss franc would have a mild upper hand against the euro, but that might not be very noticeable. So overall, we'd prefer to short USD/CHF or long EUR/JPY this week.

In US, Fed announced at the FOMC meeting that it will expand QE3. It will purchase longer-term Treasury securities at a pace of USD 45B per month after Operation Twist expires at the end of December. Purchases will be open-ended, additional to current purchases of mortgage-backed securities totaling USD 40B per month. Moreover, the FOMC has replaced its time-based guidance on monetary stance with specific numbers for inflation and unemployment rates.

The Fed would keep its easy money policies in place until unemployment rate reaches 6.5% or inflation is about to exceed 2.5%. Concerning the economic outlook, the Fed noted that employment continued to expand at "a moderate pace" recently with the unemployment rate declining somewhat although "it remains elevated." Inflation was running "somewhat below" the Committee's longer-run objective excepting the impact of energy prices. The FOMC staff projection showed a small downward revision in near-term expectations for the unemployment rate. More in Fed Expands QE3, Adopts Data-Based Guidance.

In Europe, release of the next tranches of bailout fund for Greece, EUR 49.1b, is finally approved. Greece with get EUR 34.3b "in the following days" and the rest will follow in early 2013. The Eurogroup said it's "convinced that continued fiscal and structural reforms, building on the strong commitment demonstrated in the recent past and the wide range of reforms already carried out, will allow the Greek economy to return to a sustainable growth path."

Earlier in the week, Greece said it will buy-back bonds with total face vale of EUR 31.9b, overshooting it's EUR 30b target. An average of 33.8% face value for the bonds maturing from 2023 to 2042 would be paid. EU finance ministers agree on banking union with ECB supervising eurozone banks while other EU states could join on a voluntary basis. The new supervisor should be ready by March 1, 2014.

European Council president van Rompuy said in a document that a future eurozone budget and binding economic reform contracts would be presented as a "possible measure" in June. Van Rompuy will also prepare a proposal for "solidarity mechanism" to reward governments that adhere to preagreed reform programs.

In its monthly bulletin, ECB said that its measures "have helped to alleviate banks' funding pressures and have prevented disorderly deleveraging by banks and non-financial private sector." And there are developments that indicates that the "degree of financial fragmentation in the euro area may be declining." However, borrowing costs "continue to vary greatly across the euro zone" and "in countries under stress, capital and market-based funding constraints continue to limit the supply of bank credit to the economy." Also, ECB expects economic weakness to "extend into next year." But it remained optimistic that "later in 2013 economic activity should gradually recover, as global demand strengthens."

In ECB's Financial Stability Review, it noted that "key financial-stability risks remain and there is no room for complacency." And, "an unequivocal commitment by the ECB to combat unfounded concerns about euro revocability has played a key role in this development by mitigating the tail risks that had been priced in to financial-asset prices." There are three key risks identified including waning government efforts, deterioration in bank profitability and credit quality, and fragmented markets.

The ECB said it's cannot address the "root causes" of the crisis. And, "strides toward improving fundamentals at the national level, whilst simultaneously working to sever sovereign-bank feedback loops, are critical to resolving the pernicious fragmentation of funding and capital markets."

The SNB left the target range for the 3-month Libor at 0.0-0.25% and maintained the minimum exchange rate of CHF 1.20 per euro unchanged. Concerning the economic outlook, the central bank expects Swiss economy to grow +1% in 2012 and +1% to +1.5% in 2013. For inflation, the SNB expects it to fall to negative level of -0.7 this year before recovering to -0.1% in 2013 and +0.4% in 2014.

According to the statement, "the downside risks for the Swiss economy remain considerable" and the impacts from the eurozone could be huge. The central bank stated that “although the measures announced by the European Central Bank have significantly reduced the probability of extreme developments in the monetary union, there is still substantial uncertainty." More in SNB Leaves 3-Month Libor At 0.0-0.25%, And EUR/CHF 1.2 Or Above.

The quarterly Tankan report from BoJ released showed large manufacturers' index dropped to -12 in the current quarter, comparing to -3 in prior quarter, and expectation of -9. Territorial dispute with China weighed down on the already weak exports. BoJ is widely expected to expand its easing program this week. It's likely that the central bank will add another JPY 5-10T to its current JPY 91T asset purchase and lending program. However, markets are indeed looking beyond the meeting as much more work is needed to be done from the central bank to bring sustainable recovery.

The Liberal Democratic Party is widely tipped to regain power in Japan after the election on Sunday and former prime minister Shinzo Abe is expected to replace current prime minister, Democratic Party of Japan's Yoshihiko Noda. Abe is known for his strong push for "unlimited easing" from BoJ of achieving a 2% inflation target, which is comparatively much more than the current 1% target. Also, this week's extension of easing in in US would give Abe more bullets to pile pressure on BoJ, not just on deflation, but also on growth.

In China, the HSBC manufacturing PMI rose to a 14-month high of 50.9 in December, up from November's 50.5. Also, that's the fifth straight month of gain. HSBC said that the recent surveys showed that "ongoing growth recovery is gaining momentum, mainly driven by domestic demand conditions." Nonetheless, it also mentioned that " the drop of new export orders and the downside surprise of November exports growth suggest the persisting external headwinds." Also, it noted that "calls for Beijing to keep an accommodative policy stance to counter-balance the external weakness, provided inflation stays benign."