Market Drivers - Currencies

Today's calendar is not particularly full but is the last trading day in an eventful 2011. The latter combined with very thin markets may result in some movements, but the trading session in Asia (night/morning) has so far been very calm - focus on fixings at 2.15 p.m. and 5.00 p.m. EURJPY has consolidated very close to 100 with rumours of massive stops just below - for short-term speculators the level of 100 will function as a 'red cloth before an angry bull'. In the currently thin markets an 'attack' on the level of 100 will be fairly 'cheap' and thus more likely but also easier to 'defend'. A downward breach of this level will actually open up for a long-term movement towards 90. In the short term, we consider a correction early in the year fairly likely, and we remove our BUY recommendation but will still look for a BUY recommendation somewhere below 100.
Next week will really be characterised by economic indicators. On Monday, PMI data for industry in Europe and Sweden will be announced. On Tuesday, PMI data for industry in Norway, Switzerland, the UK and the US will be announced. On Wednesday/Thursday, the slightly less important PMI service figures in the same countries will be released and on Friday the important employment figures from the US will be published. In other words, we are in for an exciting start of the new year, and if we combine the prospects above with respect to economic indicators with the excitement about the Southern European interest rates (will the banks start buying up in the beginning of 2012), we are in for wide fluctuations.

EUR/USD (NEUTRAL): We maintain our recommendation of placing a sell order at 128.49. The beginning of 2012 may go both ways, and it should not come as a surprise if, in early 2012, we adjust our recommendation to BUY although we anticipate a lower EUR/USD for the long term.

EUR/PLN (SELL to NEUTRAL): We reached our recommended buy-order level at 440.50. The recommendation was spot on - the cross rose by 1.5% over the day to above 446. BUT the central bank decided (slightly unexpectedly) to intervene (cheap action in the thin market), and hence the cross has declined again. We maintain our recommendation and expect to reach 451.50 again. Today, currentaccount data (Q3) will be released.

EUR/SEK (NEUTRAL): As mentioned over the past days, we still believe that the cross looks attractive for an upward movement. Therefore, we have also issued a long-term investment case - read here. We recommend investors to buy an options strategy.

EUR/GBP (BUY): The cross has increased slightly and has breached 83.75 as the first point of resistance and if it closes above 84.25, 86.50 will be within close reach.

EUR/JPY (NEUTRAL): The SELL recommendation has been closed (+2.15%).

Disappointing Italian Debt Auction Sends Euro Lower

EURUSD hit fresh lows of 1.2858 yesterday, after an Italian auction of long-term debt did not go nearly as well as the shorter term auctions the day before. The yield on 10-year bonds was just a whisker lower than the unsustainable 7% level (at 6.979%), and in spite of the Treasury aiming sell EUR8.5bn of its debt, only around EUR7bn could be placed. The silver lining to be gleaned from the event was that yields on bonds with maturities between 3 and 10 years were all lower than last month's record highs; but this news was clearly not encouraging enough to support prices in the secondary market as the ECB still had to step in to prop up the bonds later on.

All this adds up to a sour end of 2011 for Italy and the Eurozone, and an indication of how tough 2012 is likely to be when politicians return to the task of managing the sovereign debt crisis. While the pessimism surrounding the Eurozone has noticeably impacted both the currency and bond markets, equities have actually performed rather well in the past day. In this morning's Asian session, the Nikkei has closed up 0.7%, with the Hang Seng up 0.4% and Shanghai Composite also up 1.2%.

Coming up in today's session, the Swiss National Bank will publish its latest balance sheet data and the Bank of England will release the latest UK housing equity withdrawal numbers, but otherwise it will be a rather quiet day on the data release front.

Euro Under Pressure as Year Ends

The euro produced mixed results against its major counterparts as the last Italian bond auction for the year recorded lower yields but did not reach the expected demand. The yields fell compared to November’s auction, but only EUR 7 billion was bought with EUR 8.5 billion expected. Versus the US dollar, the single currency rose to 1.2952 from 1.2925. It had earlier reached 1.2858, a 15-month low. Against the Japanese yen, the euro dropped to 100.60 from 100.75, having touched 100.06 a near-decade low. Versus the Australian dollar, the single currency fell to 1.2771 from 1.2824, recording a fresh all-time low at 1.2755.

It will be interesting to see how the euro will behave today, the last trading day of the year,
The US dollar was softer against a basket of currencies as macroeconomic data pointed towards an increasingly firmer economy. Figures showed economic activity in the US expanding more than forecast, with Pending Home Sales and Chicago’s business barometer, the Purchasing Managers Index, both beating expectations. Versus the Swiss franc, the US dollar slid to 0.9402 from 0.9434. Against the Canadian dollar, the greenback dropped to 1.0206 from 1.0256. Versus the Japanese yen, the US dollar moved down to 77.66 from 77.93.

The Australian dollar rose to 1.0138 from 1.0076 against the US dollar, as Asian stocks extended their rally and this boosted demand for the high-yielding currency. The British pound fell to 1.5414 from 1.5437 versus the US dollar.

Oil prices rose to 99.33 dollars a barrel from 99.24. Gold fell to 1549.40 dollars an ounce from 1555.55. Silver climbed to 27.6925 dollars an ounce from 27.0513.

No Sparks on Last Trade Day of the Year...

With many traders looking to get a jump on the long New Year holiday weekend, currency markets in Asia were not unexpectedly quiet. With thinned liquidity, end of year flows helped jam the Aussie dollar higher early on in the session. The moves helped to send the AUD/USD through 1.0170, the AUD/JPY just shy of the 79.00 handle, and the EUR/AUD saw fresh record lows near 1.2725 to complete a 10 or so big figure drop since late November. The EUR/USD remained content within a 1.2925 to 1.2955 range. With no real major news to spark market moves, we saw end of year dealing as a prime mover in the holiday thinned markets. Slightly disappointing Chinese HSBC manufacturing PMI data that came in at 48.7 as opposed to last month's 49.0 helped put a sour tone on risk for the day as well.

The yen again saw firming in the crosses as the AUD/JPY shed early gains and the EUR/JPY again looked to threaten the ominous options barrier at the 100.00 big figure. An earlier run at this level in New York just fell short near 100.05 while the move in Asia saw lows nearer to 100.20. GBP/JPY saw lows near 119.35 and the AUD/JPY dropped from near 79.05 to 78.55 for one of the day's bigger moves.

With the New Year holiday weekend upon us, look for currency markets to regain momentum once we get underway again next week. In the mean time keep in mind that Japan has a four day weekend while the US will be closed for a three day weekend in observance of the New Year. To everyone out there reading this, Happy New Year, with health, happiness and prosperity in 2012.....

Dollar to Remain Unloved, but Unavoidable

To mis-quote Churchill, the dollar in 2012 is likely to be the worst major currency, except for all the others. Reserve managers and funds will still want to diversify away from the US currency in the medium term, but a lack of attractive alternatives and the sheer necessity in holding the currency should help keep the dollar afloat for a while longer, especially as the love affair with alluring BRIC economies is under strain. Timing is, as always, critical and the generally bullish consensus on the currency for 2012 is a concern. Overall, the dollar should start the year on a strong footing and the 1.15 area against the Euro is within reach, but it is likely to hit a peak before mid-year.

From a low point in May, the dollar has regained close to 10% on a trade-weighted basis with the Euro retreating from a high close to 1.50 to below 1.30 as Euro-zone fears increased and the ECB was forced to back-track from disastrous interest rate increases. There has been a shift in expectations surrounding the US economy as the mid-year slide towards recession has been halted. As the fourth quarter progressed the economy gathered momentum with gains for consumer spending and employment. Crucially, there has also been a shift in the Federal Reserve stance and funds have been drawn back to the dollar.

The Fed stood poised over the trigger for further quantitative easing early in the third quarter, but was able to hold back from further action as indicators improved. There should be further momentum at the start of 2012 which will help support the dollar. Yield spreads have moved back in the dollar's favour with 2-year bond spreads over German bunds positive for the first time in a year and the dollar is still undervalued.

It is, however, extremely difficult to build an independent bullish case for the dollar as the US still has to tackle extremely serious structural vulnerabilities. The fiscal position is a disaster as the Federal budget deficit remains out of control and there will be the threat of further credit-rating downgrades, especially as the political cycle is not conducive to cohesive action during 2012. The foundations for an extended period of strong growth are still not there given the individual and government debt levels, although there is at least hope that housing-sector volumes are recovering. The Fed may have held back from additional easing, but policy will certainly remain very accommodative throughout 2012 and there is little doubt that Bernanke will pull the trigger again if the economy threatens to stall.

If the telescope is pulled back to allow a more global view then the dollar's prospects brighten. The Euro-zone will continue to face severe structural problems throughout 2012. Even if the club can be kept together and this remains highly uncertain at best given the desperate Greek situation, there will be strong pressure for the ECB to pump additional money into the system to help avert a collapse in the banking sector.
Emerging markets are looking somewhat tarnished in general with a particular focus on the threat of a sharp slowdown in China while the Indian outlook has darkened. There was an important shift in trends during 2011 as Asian countries in general changed from being net dollar sellers to stop their currencies appreciating to net dollar buyers to prevent losses. Overall, there is likely to be a further net flow of funds into the dollar early in 2012.

This trend is likely to be enhanced by a further spasm of de-leveraging from within the global banking sector. Capital levels remain too low, especially as sovereign-debt has had to be re-classified as having inherent risk. De-leveraging will continue to underpin the US dollar as risk assets are sold off.

Risk Rebounds...

Thursday saw risk assets ride a much needed relief rally as a continuing stream of encouraging US data soothed sentiments. While weekly jobless claims edged higher to 381k vs. expected 375k, Chicago PMI printed better at 62.5 for December vs. expected 61 and Pending Home Sales jumped +7.3% in November vs. broad market expectations for a +1.5% rise.

The S&P 500 and DJIA climbed higher by about +1.1% on average and the greenback fell back against both G10 and EM currencies as the euro recaptured the 1.2900 handle. US (WTI) and UK (Brent) crude oil neared $100/bbl and $108/bbl, respectively, as risk assets rallied across the board.

However, we think caution should be heeded for any moves seen this week as they may not accurately represent the opinion of the entire market due to the thin volumes accompanying the holiday trading week.
The data slate ahead in the Asia Pacific Session is relatively light. Australia November Private Sector Credit is set for release at 1930ET but all remaining eyes will be on HSBC December Manufacturing PMI due out at 2130ET.

China HSBC Manufacturing PMI printed at 47.7 in November suggesting contraction; any number below the prior may see risk assets pare back Thursday's gains while a print above 50 may see further gains.

Better US Data Boosts Risk Appetite and Caps the USD Overnight

Another day spent in tight ranges during the Asian session after risk currencies rebounded overnight following an extended early sell-off.

The final data releases for the year gave us the first indications of manufacturing activity for the Asia region in December. Following yesterday's string of disappointments, Japan at least had something to cheer about when the manufacturing PMI data was released. The index rose back above the 50 expansion/contraction threshold (just!) following last month's dip to 49.1 with a rebound to 50.2. For China, the data was not quite so encouraging with the HSBC manufacturing PMI stuck below the 50 mark for the second month running, though there was some improvement from last month's 47.7. The flash estimate a few weeks back suggested a reading closer to 49.0.

Australian data releases were second-tier and showed private sector credit marginally higher in November compared to October with a 0.3 percent m/m increase from 0.2 percent. Housing credit rose 0.5 percent m/m versus 0.4 percent previously and is a further indication that the Australian consumer remains cautious at best and scared at worst but; perhaps more of a concern was the lack of momentum in business lending with flat growth recorded in both October and November.

After looking quite perky at the Asian close yesterday, the EUR succumbed and fell to technical targets at the 1.2850 level as Italy's bond auction proved less than inspiring (yes, yields were lower but there was a shortfall in demand in the shorter tenor) and headline German CPI data came in marginally below forecast at +0.7 percent m/m and +2.1 percent y/y (its lowest reading since March).

Having found some support just above 1.2850, the EURUSD's rebound gathered more steam as US data instilled a better risk appetite. The Chicago PMI reading beat forecasts to hit 62.5, marginally below last month's 62.6 print but encouragingly above the consensus 61.0. The better data from the housing sector continued with pending home sales rising 7.3 percent m/m in November versus a 1.5 percent consensus. While the headline weekly jobless claims data was a mild disappointment compared to recent weeks (rising to 381k from a revised 366k and a forecast 375k), the four-week moving average fell to its lowest level since June 2008 (375k) and is an encouraging sign for payroll data early next year. The other headline disappointment was the weekly Bloomberg consumer comfort index which dipped back to -47.5 from -45.0 but again the 4-week moving average is still posting gains after the recent low in mid-November. All-in-all the data was viewed positively resulting in a reduction in risk aversion and a rebound for the risk currencies.
As we enter into the New Year celebrations over the weekend, China will be releasing its official manufacturing PMI data for December on New Years' Day.

HAPPY NEW YEAR TO ALL AND A HAPPY AND PROSPEROUS 2012!

Data Highlights

• US Initial Jobless Claims out at 381k vs. 375k expected and revised 366k prior
• US Continuing Claims out at 3601k vs. 3600k expected and revised 3567k prior
• US Dec. Chicago PMI out at 62.5 vs. 61.0 expected and 62.6 prior
• US Nov. Pending Home Sales out at +7.3% m/m vs. 1.5% expected and 10.4% prior
• US Dec. Kansas City Fed Manufacturing Activity out at -4 vs. +6 expected and +4 prior
• JP Dec. Markit/JMMA Manufacturing PMI out at 50.2 vs. 49.1 prior
• AU Nov. RPData-Rismark House Prices out at -0.2% m/m vs. revised -0.3% prior
• AU Nov. Private Sector Credit out at +0.3% m/m, +3.5% y/y vs. 0.3%/3.6% expected and 0.2%/3.5% prior resp.
• China Dec. HSBC Manufacturing PMI out at 48.7 vs. 47.7 prior

Upcoming Economic Calendar Highlights (All Times GMT)

• UK Nationwide House Prices (0700)
• Sweden Wages - Non-manual Workers (0830)
• UK BOE Housing Equity Withdrawal (0930)
• US NAPM-Milwaukee (1500)

Stocks Rally as Year Comes to Close

U.S. Dollar Trading (USD) was stronger against most pairs in Europe's after Italy's bond Auction failed to stop yields remaining at 7%. The sentiment improved during the US session and the dollar gave up some of it gains with bargain hunter snapping up stocks from depressed levels. Chicago PMI remained strong at 62.5 vs. 61 forecast. Weekly Jobless Claims moved higher however to 381k vs. 366k. Looking ahead, no data today.

The Euro (EUR) with bond auctions failing to sell the full allotment the market sold EUR/USd down to 1.2860 supports before reversing with positive US stocks and profit taking ahead of the last trading day of the year. Some support was also seen from reports that Eurobonds are still an option in the future if the right changes are made to the EU treaty. Looking ahead, no data today.

The Japanese Yen (JPY) USD/JPY moved lower on USD weakness but most crosses held ground or gained on the day with US stocks up 1%. Support is seen in lower Y77.50 but more attention is on EUR/JPY which found support at Y100 on its first test.

The Sterling (GBP) failed to bounce with the rest of the majors and instead remained at the 1.5400 level while crosses lost ground. EUR/GBP move back to 0.8400 with traders suggesting year end flows are particular heavy on GBP sales. The outlook is negative while below 1.5500 on Cable.

The Australian Dollar (AUD) the US session saw AUD/USD lead the other currencies higher with a move to 1.0150. This was despite heavy gold selling and Oil weakness with the market instead following stocks. The range is still holding even as GBP and EURO break to the downside and this is letting the Aussie gain on most crosses. Update December HSBC PMI revised to 48.7 vs. 49 first printed.

Oil & Gold (XAU) Gold slipped to the next support level at $1520oz before paring losses later in the day. OIL/USD tested $98.50 support before rallying late in the day back to $100 a barrel.

Risk Rebounds...

Thursday saw risk assets ride a much needed relief rally as a continuing stream of encouraging US data soothed sentiments. While weekly jobless claims edged higher to 381k vs. expected 375k, Chicago PMI printed better at 62.5 for December vs. expected 61 and Pending Home Sales jumped +7.3% in November vs. broad market expectations for a +1.5% rise.

The S&P 500 and DJIA climbed higher by about +1.1% on average and the greenback fell back against both G10 and EM currencies as the euro recaptured the 1.2900 handle. US (WTI) and UK (Brent) crude oil neared $100/bbl and $108/bbl, respectively, as risk assets rallied across the board.

However, we think caution should be heeded for any moves seen this week as they may not accurately represent the opinion of the entire market due to the thin volumes accompanying the holiday trading week.
The data slate ahead in the Asia Pacific Session is relatively light. Australia November Private Sector Credit is set for release at 1930ET but all remaining eyes will be on HSBC December Manufacturing PMI due out at 2130ET.

China HSBC Manufacturing PMI printed at 47.7 in November suggesting contraction; any number below the prior may see risk assets pare back Thursday's gains while a print above 50 may see further gains.

Euro Plunges On Massive Expansion Of ECB Balance Sheet

Financial markets may look deceptively subdued again today, but there is a notable difference between this morning and the start of previous sessions this week. Negative euro sentiment has seemingly returned from vacation before the start of the new year, taking EURUSD down to lows of 1.2888 – a collapse of almost 200 pips from yesterday morning's levels.

Perhaps surprisingly, the scheduled auction of Italian debt did not appear to be the key driver of the euro move. Italy's Treasury managed to sell some EUR9bn of 179-day bills at a reasonable rate of 3.251%; down significantly from the eye-watering 6.504% seen at the 25 Nov auction. Instead, the culprit for the euro's sudden plunge seemed to be the ECB's release of its latest balance sheet. The latest snapshot of ECB activity revealed an alarming expansion in the size of the balance sheet from EUR239bn to a whopping EUR2.73trn – clearly well in excess of the market's expectations. The news not only triggered an adverse reaction for the European currency, but also had a knock-on effect on European equity markets; France's CAC40 closed down just over a percent yesterday, and Germany's DAX ended the day down over 2 percent.

Coming up in today's session we will receive the latest regional CPI readings from Germany, along with Eurozone M3 figures for November. This afternoon, US data releases include this week's jobless claims, Chicago PMI, pending home sales and Kansas City Fed manufacturing survey.

Euro Falls, Caution ahead of an Italian Debt Sale

The euro sharply dropped yesterday with markets in a risk-off mood in poor year-end liquidity. Italian bond auctions were successful yesterday. Investors are now waiting to see the result of today’s auction of a sale of up to 8.5 billion euro of Italian bonds. Versus the greenback, the single currency broke below the 1.29 level falling to near a one-year low at 1.2887 from 1.3079. Against the Japanese yen, the single currency hit a ten-year low as selling from Japanese retail investors and exporters weighed on the euro in a low liquid year-end market.

The US dollar rose against a basket of currencies in thin post-Christmas trading. Versus the Japanese yen, the greenback traded as high as 78.03 from 77.56 and today the pair surrendered some of its gains to trade as low as 77.67. Economic data disappointed investors after the Swiss KOF Indicator fell to 0.01, much lower than expectations, adding on fears that the economy in Switzerland is deteriorating. Versus the Swiss franc, the greenback jumped as high as 0.9452 from 0.9320. Focus turns to Initial Jobless Claims, Purchasing Managers’ Index and Pending Home Sales expected later today.

The Australian dollar slid to a one-week low versus the greenback at 1.0044 from 1.0202. The Aussie which followed the decline in the euro remains vulnerable in thin year-end conditions ahead of today’s Italian bond auction.

Oil prices fell to 98.81 yesterday dollars a barrel after a surge above 100 dollars a barrel on concerns about possible supply disruptions due to rising Middle East tensions. Gold dipped to 1543.60 dollars an ounce from 1592.90. Silver edged lower to 26.71 dollars an ounce from 28.77.

USD Jumps in Thin Liquidity - More to Come Before Year-End?

Thin markets were caught with some USD positive flows with much discussion as to what the actual driver of the USD buying was. Whether it is the start of year-end flows, delayed reaction to the geo-politicking by Iran or International Monetary Fund comments on Hungary's ability to meet targets for additional support, it does seem that the market was picking at stories to fit the move with thin liquidity exaggerating the move. Expect more of this scenario in the last days of trading of 2011.

Not much to report from the Asian session with all of yesterday's movement occurring late in the European session. The initial move was to extend the EUR's down-move (USD's gains) to new December lows below 1.29, eventually stalling at 1.2888. After that, it was a slow grind higher though again volumes were severely restricted.

The data calendar was bare and no news to drive markets so regional bourses traded on the heavy side in the wake of Wall St's fall last night, though a positive print in S&P futures helped stabilise losses.
After yesterday's almost blank data calendar, things pick up today with Germany releasing CPI data from its various states along with Eurozone M3 money supply and Sweden's trade balance. The US session features the weekly jobless claims data with better-than-expected data noted for the past three weeks.
The Chicago PMI data for December is also due with surveys suggesting the market is not convinced about last month's spike to 62.6 with median forecasts at the 61.0 level. Weekly Bloomberg consumer comfort data comes next with last week's uptick to 45.0 maybe looking a tad overdone. We also see the pending home sales data for November (housing data of late bringing a more positive tone) and finish with the Kansas Fed manufacturing activity index.

Data Highlights

• Sweden Nov. Retail Sales out at +0.8% m/m, +0.7% y/y vs. -0.3%/-1.0% expected and +0.4%/-0.6% prior resp.
• Swiss Dec. KOF Leading Indicator out at 0.01 vs. 0.23 expected and revised 0.34 prior

Upcoming Economic Calendar Highlights (All Times GMT)

• GE CPI - Various States (n/a)
• Sweden Trade Balance (0830)
• EU Euro-zone M3 Money Supply (0900)
• US Initial Jobless Claims (1330)
• US Chicago PMI (1445)
• US Bloomberg Consumer Comfort Index (1445)
• US Pending Home Sales (1500)
• US Kansas City Fed Manufacturing Index (1600)

EUR/JPY Drop Wakes Up Asia....

Once again, Asia suffers through another holiday week sleep fest with an early session bombardment of the Euro the lone notable event of the day. The big move of the week so far was the drop in risk we saw earlier today in New York trading hours, Asia saw a bit of follow through though as traders took advantage of thinned markets and made a full assault on a well noted options barrier at the 100.00 level in the EUR/JPY. The slide from 100.70 to 100.30 helped spark a drop in risk across the board. The EUR/USD slipped from 1.2920 to under 1.2890 while the AUD/USD touched 1.0040 lows after a start nearer to 1.0080. The moves were fleeting however, as the affected risk currencies rebounded nicely to fresh session highs as the morning wore on.

The week between Christmas and the New Year has traditionally been a harrowing one in currencies, with thin markets at the mercy of big funds closing out positions as well as funds facilitating year end redemptions. This has been a big driver of late in the precious metal markets as Gold and Silver continue to lose luster in December. Gold, which at times has seemed invincible, has dropped to the tune of almost $200 this month alone. Elsewhere, the yen saw some strengthening as the crosses dove lower on the EUR/JPY move; USD/JPY even got in on the activity and slipped about 20 pips on the day to 77.75.

Looking ahead, markets are focused on the upcoming Italian 10 year bond auction which is slatted to begin at 9:00GMT. This will prove to be another pivotal barometer on the overall health of the Euro and the economy of Italy. Also of note would be keeping an eye on the current verbal sparring between the U.S. and Iran as the oil rich nation continues to saber rattle and threaten a closure of the Persian Gulf while the U.S. promises that they will not let such a thing happen on their watch. Certainly a situation that will merit possible moves in risk, energy markets and gold.

Euro Back Under Pressure

U.S. Dollar Trading (USD) stocks fell on the first full trading day this week with Eurozone debt concerns the main catalyst for the move lower. Tensions in the Middle East are also providing a risk off mood as the US 5th Fleet countered Iran's threats of closing the Strait of Hormuz. Looking ahead, December Chicago PMI forecast at 61 vs. 62.6 previously. Also Weekly Jobless Claims forecast at 375k vs. 364k previously.
The Euro (EUR) bond auctions for short term Italian debt were successful but the bounce was short lived and heavy Euro selling later in the US session sent the major through 1.3000 and new multi-month lows near 1.2900. The outlook is now negative technically but there are more important auctions today including a 10 year Italian which may change the Euro's direction. Looking ahead, November Private loans forecast at 2.6% vs. 2.7% previously.

The Japanese Yen (JPY) USD/JPY remained under pressure as EUR/JPY slumped and dragged the major lower. EUR/JPY is close to the Y100 level and a break below could prompt action from BOJ officials. The Japan Finance minister spoke about interventions being necessary and they have successfully stabilized the USD/JPY.

The Sterling (GBP) was dragged aggressively lower with stocks/Euro falling below 1.5600 and then 1.5500 in the US session. The outlook is negative while the Eurozone debt crisis rolls on. The USD is very strong in recent sessions and without some good news a move below the bottom of the recent range at 1.5400 is very possible.

The Australian Dollar (AUD) Slumped with risk off trade and is now targeting the major big figure at 1.0000 if stocks continue to press lower. AUD/JPY is struggling as USD/JPY is kept capped and the recent rally may be unwound if support at Y78 is broken on the Aussie cross.

Oil & Gold (XAU) Gold fell heavily down to $1550 with support crumbling in the US session. Oil fell back below $100 as the initial reaction to Iran's threat wore off with most analysts believing it is just a bluff to prevent strikes on its Nuclear program.

Preview: US Jobless Claims, Chicago PMI, Pending Home Sales

Release: Jobless Claims (Week Ended Dec 23rd)
Consensus Forecast: 372K
Previous: 364K
Date/Time: 12/30/11 8:30AM ET (13:30 GMT)
Jobless to Remain Below 400K, A Positive Sign for NFP

First up in tomorrow's session will be our latest weekly reading on new jobless claims. This indicator has certainly moved in a positive direction of late falling and staying below the 400 K level positive signs of labor market. Expectation is that for the week ending December 23th jobless claims rose by a round 8K to 372K from the previous reading of 364K.

While a setback the key here is that claims remain to print below the 400K level as that is historically the level at which non-farm payrolls print more jobs than needed to keep up with new entrants into the labor force.
While not superb the last five months have seen non-farm payrolls coming in at around 120K - also consistent with a level needed to absorb those new to the labor force. While a larger figure is needed in payrolls to meaningfully bring down the unemployment rate, if the US continues to see the trend of firings falling then that bodes well for the labor market.

Recent consumer confidence reports - both from the Conference Board as well as the University of Michigan - have shown that consumers feel more optimistic about the labor market with the internals of the Conference Board index showing those consumers feeling that jobs are plentiful at the best level since January 2009. Therefore, if jobless claims come in better-than-expected (that is smaller than forecast) that will continue the trend we see in the above chart which shows improvement. However, a worse than expected reading could undermine expectations for December's non-farm payroll which is set to be released next Friday.

Release: Chicago PMI (December)
Consensus Forecast: 60.4
Previous: 62.6
Date/Time: 12/30/11 9:45AM ET (14:45 GMT)

The Chicago PMI is significant because it tends to track the national ISM manufacturing index quite closely and therefore is a good leading indicator for that more important release. The manufacturing PMI came in at 52.7 for November (not pictured the below graph).

In November the Chicago PMI rose to 62.6 the best reading since April, but the expectation is for the index to fall back down to 60.4 according to the consensus forecast. That still it shows a strong pickup in activity as the 50 level separates expansion from contraction though would mean a slower pace of growth.
Therefore the data tomorrow will give us a good indication of how national manufacturing performed though that read these does not come out till next Tuesday. The better-than-expected report would signify that they US economy which has seen better data of late continues to show some momentum and can help stocks to rebound from the falls we saw in Wednesday's session. That could help to bolster higher-yielding and commodity and growth linked currencies at the expense of the USD.

Release: Pending Home Sales m/m (December)
Consensus Forecast: 1.7%
Previous: 10.4%
Date/Time: 12/30/11 10:00AM ET (15:00 GMT)

The final report tomorrow from the US we get a look at pending home sales which are expected to show a 1.7% increase in November following it's and .4% rise in October. The pending home sales is tricky because the measure is taken prior to the closing and many deals can fall through if the buyer cannot find financing from a bank for instance. it is also released by the National Association of Realtors which had its credibility taken down several notches when it admitted overstating existing home sales by 15% over the last five years this month.

The data from the US housing market has been mixed as housing starts climbed to a one half year high but existing home sales released last week came in sharply below expectations along with a sharp downward revisions the previous month. Therefore out of the three releases for Thursday existing home sales may carry the least about weight.

Was Wednesday's Risk Aversion Move Towards USD an Overreaction?

In Wednesday's session we saw a heavy move towards the USD as there were several stories coming together to push the market around in thin liquidity conditions. Year-end flows and the need for companies to have USD, blustering between Iran and the US, and the release by the ECB showing its balance sheet at a record high conspired to give a very “risk off” tone to the session. The S&P 500 fell to the 1243 area and gold sold off almost $45 from its open.

Therefore, we want to see if the move towards risk aversion continues and overwhelms any reaction from US data or if the theme of the US recovery that has some momentum can create the conditions for a pullback to the trading we saw on Wednesday. We would need to see better-than-expected jobless claims and Chicago PMI for that to happen. If we have data coming in as expected, it doesn't bode well for risk as it would mean a slowdown in activity and a pick-up in firings and could mean an extension of the risk-off theme.

Preview: Germany CPI - Inflation Key to Watch for ECB Policy

Release: CPI m/m (December Prelim.)
Consensus Forecast: 0.8%
Previous: 0.0%
Release: CPI y/y
Consensus Forecast: 2.2%
Previous: 2.4%
Date/Time: 12/30/11 (Tentatively Scheduled)

Will Rising Inflation Limit Germany's Appetite for ECB Easing?

As we wind down the year, we have an interesting release coming out from Europe which is the December preliminary reading on consumer prices from Germany. We all know that Germany is the main economy in the euro zone and German authorities have important sway at the European central bank - limiting the bank from undertaking quantitative easing selectors being done in the US and UK.

The expectation for inflation is a 0.8% monthly increase compared to Novembers flat reading on prices. In annual terms inflation is expected to cool to a 2.2% rate from 2.4% previously.

The chart above we do see German inflation peaking somewhat and further move downward would be supportive of a more aggressive ECB.

We have already seen the most populous state in Germany reporting its data with prices cooling.

From Nasdaq: "Consumer prices in the German state of North Rhine Westphalia increased 0.7% in December, driven by a jump in the cost of holiday travel and accommodation, the state's statistics office said Wednesday. On an annual basis, consumer price inflation was 1.7% in December in North Rhine Westphalia, which is Germany's most populous state."

Each German state reports inflation on their own and therefore the total CPI for Germany has a smaller effect on markets.

While the data from Westphalia suggests annual prices remain tamer, if inflation comes in stronger-than-expected that would put pressure on the ECB to keep rates at the current 1% and may limit the hand of the ECB in terms of extra easing of monetary policy. German central bankers are loath to see inflationary pressures build up and have cited the fears of hyperinflation as a key reason they do not want to see the ECB undertaking quantitative easing.

In Europe as a whole consumer prices have remained stubbornly at the 3% level for several months.

The news of the ECB balance sheet hitting a record high of 2.73 trillion euros (chart below) likely had something to do with the drop in the euro on Wednesday and it will be interesting to see how German authorities respond to calls for more easing amid inflation which continues to run higher than the ECB's target.

That outgoing member of the ECB executive board Lorenzo Smaghi said that if a deflationary scenario presents itself the ECB should use QE. Therefore were going to have to closely monitor inflation that data out of Germany and the wider euro zone the coming months.

From SFGate: ""I do not understand the quasi-religious discussions about quantitative easing," Bini Smaghi, who will leave his post at the end of the month, said in an interview published yesterday by the Financial Times. The ECB confirmed the comments. "It is appropriate if economic conditions justify it, in particular in countries facing a liquidity trap that may lead to deflation."

Central banks are given a clear mandate, to achieve price stability, and the independence to achieve it through the instruments they consider most appropriate," Bini Smaghi said. "If conditions changed and the need to further increase liquidity emerged, I would see no reason why such an instrument, tailor made for the specific characteristics of the euro area, should not be used."

The German data therefore is one key consideration in the path forward for the ECB and therefore worth noting as we end the year. Coincidentally we will also get data on the European money supply which is expected to show growth of 2.5% annual pace in November.

Oil Firms on Iran Threat - Forex News and Events:

Another slow trading day with thin volumes, but at least CNBC Europe provided live coverage, unlike Monday. As the day progressed, risk appetite slowly eased out of the FX market. Equity indices had a mixed morning with shanghai composite posting marginal 0.18% gain and the Hang Seng dropped -0.69%. General uncertainty is still lingering, despite the lack of new headlines. Italian yields continue to trend higher with 10yr yields trading around 6.94%. EURUSD range consolidated further trading between 1.3057 to 1.3076 levels. Gold feels heavy, trading down to $1586 and Silver slipped to $28.58. Oil firmed slightly as Iran issued threats to block oil shipments in response to the US sanctions. On Tuesday, Iran said they would close the Strait of Hormuz, a critical route for a third of the world's oil trade. The reaction was muted due to gulf OPEC nations issuing a quick response by saying they would increase supply to offset the potential loss caused by Iran threat. In the US, the Treasury’s annual report to Congress yesterday, had the report stopping short of labeling China as a currency manipulator, but instead recognized CNY recent appreciation. In other US news, there are reports that by Friday the US deficit will reach within $100bn of its new debt ceiling. According to a Treasury department official the Obama administration will formally ask Congress to lift the nation’s debt ceiling by $1.2 trillion, to $16.39 trillion. Interestingly according to officials the adjusted debt ceiling is expected to satisfy U.S. debts until the end of 2012. We are significantly less optimistic.

Perhaps the most interesting data was the IMM report which showed that outstanding short EUR and long USD positions continue to look stretched. In addition, in the week which encompassed the SNB's decision to not shift the EURUCHF “floor”, traders cut their short CHF holding nearly in half (although the overall position was increased by one- third in anticipation only 4 weeks prior). We were surprised by the number of traders unwinding since the general consensus is that the SNB is likely to move in Q1 2012. But it just goes to show how influential analyst opinions have become as many were convinced after a particular bulge bracket banks research all but guaranteed the inside line to the SNB thought process and a December repeg. The cable also saw traders cut their shorts as official data and price action suggested that Gilts are becoming a safe haven destination for traders fleeing the uncertainly of Europe.

As for today, we have another light economic calendar with the highlight in our eyes to be the Swiss KoF leading indicators read. The indicator is expected to further decline to 0.23 vs. 0.35 prior read. In early Europe, EURCHF has found buyers as the weak indicator is expected to spark another round of verbal intervention from the SNB, then a highly probable repeg. With speculators recently cutting their short positions a surprise to the downside could trigger a rebuild in EURCHF long in anticipation of a Q1 2012 change in SNB exchange rate policy.

 

Today's Key Issues (time in GMT):

 

• 07:45 EUR France: Maastricht debt, % GDP Q3
• 08:30 SEK Retail Sales, % Nov
• 10:30 CHF KoF leading indicator Dec

The Risk Today:

 

EurUsd Not much doing in FX. EURUSD continues to consolidate in thin holiday markets with topside minor resistance at 1.3077 (intraday high), 1.3237 (13th Dec high), 1.3456 (8th Dec high), 1.3553 (9th Nov high), 1.3852 (61.8% Fibo retracement). Initial demand is located at 1.3017 (22nd Dec low), 1.2994 (20th Dec low), 1.2945 (14th Dec low), 1.2867 (1st Jan low 11) then 1.2600 (76.4% Fibo retracement).
GbpUsd The cable continues to grind higher making short work of near-term resistance. Resistance should kick-in at 1.5680 (27th Dec high), 1.5780 (30th Nov high), 1.5805 (21st Nov high), then 1.5880 (61.8% Fibo retracement). Next level of demand will come into play at 1.5570 /90 (16th Dec high), 1.5333 (23rd Sept low), then 1.5272 (6th Oct low).

UsdJpy The pair has spent the last 8 hr in a 6 pip range. USDJPY seems to have gone back to sleep as we predicted. Initial critical support will come into play at 77.45 (daily cloud top), 76.11 (22nd Sept high), then 75.35 (31st Oct low). Resistance can be seen at 78.29 (30th Nov high), 79.53 (31st Oct intervention high), 80.24 (prior intervention high) then 81.48 (8th July high).

UsdChf USDCHF remains stuck in its 0.9300 to 0.9400 range. Next resistance is located at 0.9400 (22th Dec high), 0.9415 (16ht Dec high) then 0.9603 (17th Feb high). Next support region is located 0.9180/ 96 (9th Dec low), 0.9117 (65d MA), 0.9066/71 (30th Nov & 1st Dec low), 0.8963 (14th Nov low) then 0.8923 (8th Nov low).

Morning Forex Fundamental

EUR

I expect further cheapening of [Italian] bonds" - Alessandro Giansanti, rate strategist at ING
News: Italian bond yields rise before auction
Impact: High
Italian government bonds fell on Tuesday, pushing three-year and ten-year yields higher before an auction on Thursday, where Rome plans to sell 8.5 billion of debt, as investors are worried the euro zone's third-largest economy may lose access to financial markets.
"The 10-year is the area where Italy has to rely more on foreign investors and it will be very tough to sell especially at this point in the year, so I expect further cheapening of the bond going into the auction," ING rate strategist Alessandro Giansanti said.
"The three-year would be easier to sell, there is some demand from the domestic investors. If they see really weak demand in the 10-year ... they may sell more short-term [debt]."

USD

"Consumers are more optimistic that business conditions, employment prospects and their financial situations will get better" - Conference Board Inc.
News: Consumer confidence improves in December
Impact: High
U.S. consumer confidence rose to an eight month high in December as consumers became more optimistic on the outlook of the country's economy, the Conference Board Inc. said on Tuesday. An index of sentiment increased to 64.5 from 55.2 in November.
"A large part of the problem in the economy is one of confidence, and to the extent that sentiment begins improving it would be a positive for growth," said Dana Saporta, director of U.S. economic research at Credit Suisse in New York. "Whether this will be sustained really depends on the employment situation going forward."
"While consumers are ending the year in a somewhat more upbeat mood, it is too soon to tell if this is a rebound from earlier declines or a sustainable shift in attitudes," said the Conference Board in a statement.
 
GBP

"U.S. data is providing what markets have been looking for in terms of a wider economic improvement and rising employment" - Witold Bahrke, a senior strategist at PFA Pension A/S
News: U.K. stocks rose on Friday
Impact: High
U.K. banks were closed on Tuesday in observance of Boxing Day.
U.K. stocks rose on Friday amid better than expected economic data from the world's largest economy. The benchmark FTSE 100 index gained 1.02%, or 55.73 points, to 5,512.70. The FTSE All-Share Index edged higher 0.98%, or 27.48 points, to 2,827.09.
"U.S. data is providing what markets have been looking for in terms of a wider economic improvement and rising employment," said Witold Bahrke, a senior strategist at PFA Pension A/S in Copenhagen.
Nationwide Building Society is to announce its month on month house price index on Friday. Economists expect house prices to rise 0.3 percent in December, after increasing 0.4 percent in November.

CHF

"With small volume, the markets can move without much effort" - Benno Galliker, a trader at Luzerner Kantonalbank
News: Swiss stocks declined on Tuesday after U.S. housing report
Impact: Medium
Swiss stocks snapped a five-day rally on Tuesday after S&P/CS report showed U.S. house prices fell more than expected.
The Swiss blue-chip index SMI, a measure of the largest and most actively traded companies, shed 0.12%, or 6.98 points, to 5,886.91. The broader Swiss Performance Index edged lower 0.13%, or 6.85 points, to 5,302.10.
"With small volume, the markets can move without much effort," said Benno Galliker, a trader at Luzerner Kantonalbank in Lucerne, Switzerland. "The weak data on house prices certainly don't help. Even so, the outlook for the whole week remains optimistic."
KOF Economic Research Agency is to announce its KOF Economic Barometer later today. Economists expect the reading to decline to 0.25 from 0.35 in November.

JPY

"There's no outstanding catalyst to buy stocks" - Fumiyuki Nakanishi, a strategist at Tokyo-based SMBC Friend Securities Co.
News: Japanese stocks edged lower on Tuesday
Impact: Medium
Japanese stocks dropped on Tuesday amid slow holiday trading. The Nikkei 225 lost 0.46%, or 38.78 points, to 8,440.56, while the broader Topix fell 0.30%, or 2.19, to 724.25.
"There's no outstanding catalyst to buy stocks," said Fumiyuki Nakanishi, a strategist at Tokyo-based SMBC Friend Securities Co.
"Trading energy plunged in the Tokyo market yesterday. Today [Tuesday] as well, we can't expect foreign investors to buy shares as the overseas markets are closed."
Japan's Cabinet Office is to announce month on month change in core machinery orders January 10. Orders dropped 6.9% percent in October, compared to September.

What to Read Today

 

Europe

• The ECB allotted 489 billion euros in three year loans to 523 banks at the average rate of 1 percent on Wednesday, exceeding forecast of 293 billion euros.
• 26 EU member countries consider joining new treaty on deeper fiscal union, UK isolated; Merkel is "very pleased" with outcome of the summit.
• The ECB cut benchmark rate to 1% on December 8, but fell short of confirming it will buy EU member countries' bonds in unlimited quantities.

Euro Seen Having Another Bumpy Ride in 2012
 
http://www.cnbc.com/id/45774841

2011 was the most dramatic year for the euro in the decade since the single currency was launched.

European Stock-Index Futures Drop Before Italy Sells Debt; Areva May Move

http://www.bloomberg.com/news/2011-12-28/european-stock-index-futures-drop-before-italy-sells-debt-areva-may-move.html

European stock futures declined, indicating that the benchmark Stoxx Europe 600 Index may snap a three-day rally, before Italy sells as much as 20 billion euros ($26.2 billion) of debt today and tomorrow. U.S. index futures and Asian shares dropped.

USA

• The latest US macroeconomic data indicates that the national economic recovery is getting stronger; the number of Americans claiming for unemployment benefits fell to 364K while unemployment declined to 8.6% in November.
• Obama signed a spending bill of nearly $1 trillion on Saturday, averting collapse of federal government services; Congress approved a two-month extension of payroll tax break for 160 million U.S. employees on Friday.

Obama taps economist, banker as Fed governors

http://www.reuters.com/article/2011/12/28/us-usa-fed-whitehouse-idUSTRE7BQ0RA20111228

President Barack Obama will nominate Harvard economist Jeremy Stein and Jerome Powell, an investment banker and former Treasury official, to the two empty seats on the Federal Reserve's policy-setting board of governors.

Washington's year of drama leaves little done regarding debt

http://www.washingtonpost.com/business/economy/washingtons-year-of-drama-leaves-little-done-regarding-debt/2011/12/23/gIQAB6kRLP_story.html?hpid=z3

Reid Ribble, a Wisconsin roofing contractor-turned-Republican lawmaker, has helped change the way Washington talks about the national debt. That's not to say he has done much about the debt itself.

Asia & Pacific

• Japan's economy grew 1.4% in the third quarter 2011, while the exports fell for a second month in November as the global economy is cooling down; survey of Japanese manufacturers shows business conditions are deteriorating.
• China's industrial output contracted in December, intensifying worries the country might face hard economic landing next year whereas China's top officials guarantee growth will continue in 2012.

Japan pact raises Chinese yuan's status

http://www.marketwatch.com/story/japan-pact-raises-chinese-yuans-status-2011-12-28?link=MW_home_latest_news

An agreement reached this week that will see Japan hold Chinese bonds as part of its foreign-exchange reserves may herald the emergence of China's yuan as a new global reserve currency, according to analysts.
Japan's industrial output dips 4% on yen and flooding

http://www.bbc.co.uk/news/business-16337546

Japan's industrial production fell in November, pulled down by a strong yen, weak global demand, and after flooding in Thailand damaged many suppliers.

Low FX Volatility Prevails As Japanese Data Underwhelms

FX markets have continued to experience very low volatility over the past 24 hours, with little in the way of news or events to stimulate much trading activity. EURUSD remains around 1.3060 levels, and USDJPY is still lodged in its long-standing range between 77.75 -78.00. Asian equity markets have struggled once again today with the Nikkei once again trading lower by -0.2% and the Hang Seng -0.7%.

Earlier in the Asian session we got a glut of data out of Japan, but there was not much reaction to the results. National CPI for November dipped to -0.5% YoY (-0.4% expected, -0.2% prior), but the Tokyo CPI figures for December actually improved to -0.4% YoY (-0.6% expected, -0.8% prior). Retail trade in November was a deeply disappointing -2.3% compared to forecasts looking for 0.0%, and industrial production also undershot expectations significantly at -2.6% MoM, -4.0% YoY (consensus looking for -0.8% MoM, -2.0% YoY).

In today's session there is a very limited economic release schedule; Swedish November retail sales are forecast to drop to -0.3% MoM, -1.0% YoY (compared to October's 0.4% MoM, -0.5% YoY reading), then we round out the morning with Swiss KOF leading indicators (expecting 0.23 versus last month's 0.35).

Euro Subdued, Focus on Italian Bond Auction

The euro edged lower during the Asian session and Asian equities dropped with many market players away. Focus remains on an Italian bond auction today and tomorrow and the auctions will be closely watched as Italian yields are still struggling around the 7% level. Versus the greenback, the single currency edged as low as 1.3056 today after it traded in a tight range around 1.3065 yesterday.

The US dollar was trading in a tight range against a basket of currencies in thin post-Christmas trading. Home Price Index and Fed Manufacturing Index data came in lower than expected disappointing investors who were looking for positive signs from the US economy. Consumer Confidence rebounded to 64.5 while 56 was expected. Versus the Japanese yen, the greenback fell to 77.75 today from 78.02 after the US Treasury Department criticized Japan for intervening in the currency markets to stop the yen from rising. In a report to the US Congress, the US Treasury said that rather than intervening to influence the exchange rate, Japan should take steps to help the economy and support the competitiveness of Japanese firms.

The British pound jumped to 1.5702 versus the greenback as thin markets resulted in sharp moves but the pound’s advance was limited. Today the pair is trading at 1.5668.

Oil prices surged above 100 dollars a barrel rising as high as 101.72 from 99.27 on concerns about possible supply disruptions due to rising Middle East tensions. Gold dipped to 1586.15 dollars an ounce from 1604.11. Silver edged lower to 28.58 dollars an ounce from 29.15.

Japan Data Disappoints Currencies Mired in Tight Holiday Ranges

Currency markets remained in a lull in Asia with minimal activity seen between the Christmas and New Year period, despite some centres returning from an extended break. The highlight of the session was the early release of a slew of economic data out of Japan which was generally on the disappointing side.
Deflationary pressures were very much in evidence for the Japanese economy with headline national CPI falling a greater than expected 0.5 percent y/y in November, a faster rate than the 0.2 percent recorded in October with core inflation falling at a much faster 1.1 percent y/y. While some of the fall can be accounted for with the dropping out of last year's tobacco tax, the weak global outlook and under-performing local economy will make it hard work for the Bank of Japan to match its forecast of inflation at, or just above, zero percent through 2013/14.

While headline industrial production for November was disappointing, -2.6 percent m/m and -4 percent y/y compared with consensus -0.8 percent/-2.0 percent respectively, there was some comfort to be gained from the predictions for manufacturing output with December's forecast revised to a higher 4.8 percent from 2.7 percent and January's output expected to rise by a further 3.4 percent. Much of this improvement lies in the reinstatement of supply chains following the recent floods in Thailand, a major production base for many major Japanese manufacturers.

Finally, Japan's jobless rate held steady at 4.5 percent and was bang in line with forecasts. Predictably, the JPY showed scant reaction to the data and, like other currency pairs, drifted in tight ranges throughout the session.
The US again failed to label China as a currency manipulator in its delayed semi-annual currency report, but still considered the moves to appreciate the Yuan to date as insufficient. This will continue to be a hot topic in 2012 as the US/China trade imbalance becomes a favourite subject for political posturing. On currency interventions, the report took a constructive view on the EURCHF peg but said it did not support the recent Japanese intervention moves saying that markets had been orderly during the August and October interventions, in contrast to the post-tsunami G7 moves in March.

Tight ranges were the norm yesterday as a number of centres enjoyed an extended Christmas break. Currency levels were barely changed from pre-Christmas levels and activity remained definitely muted. Oil prices saw a jump higher as Iran threatened to block the Straits of Hormuz if oil-consuming nations embargo exports (note Saudi Arabia assured they will step up output to replace Iran's) which has given the CAD a slight lift. The EUR's next testing moment will likely be Italy's debt auction today and tomorrow.
Yesterday's US data releases were mixed with the Conference Board's consumer confidence rising to 64.5 in December from 55.2 (highest reading since April). Manufacturing activity gave mixed signals with the Richmond Fed index rising to +3 from zero (+5 expected) while the Dallas Fed equivalent deteriorated sharply to -3.0 from +3.2. S&P/CaseShiller house price data for October disappointed with falls of 0.62 percent m/m and 3.4 percent y/y though the time lag for the series makes it irrelevant (other housing data has been showing more positive signs for the housing market of late).

For the rest of today, Europe's data releases are minimal with Sweden's household lending and retail sales together with Swiss leading indicators the only items scheduled. There is nothing scheduled for North America so these factors should keep activity subdued.

Data Highlights

• US Oct. S&P CaseShiller House Prices out at -0.62% m/m, -3.4% y/y vs. -0.4%/-3.2% expected and revised -0.66%/-3.54% prior resp.
• US Dec. Consumer Confidence out at 64.5 vs. 58.9 expected and revised 55.2 prior
• US Dec. Richmond Fed Manufacturing Index out at +3 vs. +5 expected and zero prior
• US Dec. Dallas Fed Manufacturing Activity out at -3.0 vs. +4.8 expected and +3.2 prior
• JP Nov. Jobless Rate out at 4.5%, as expected and unchanged from prior
• JP Nov. Job/Applicant Ratio out at 0.69 vs. 0.68 expected and 0.67 prior
• JP Nov. National CPI out at -0.5% y/y vs. -0.4% expected and -0.2% prior
• JP Dec. Tokyo CPI out at -0.4% y/y vs. -0.6% expected and revised -0.9% prior
• JP Nov. Retail Trade out at -2.1% m/m, -2.3% y/y vs. -0.5%/flat expected and 1.4%/1.9% prior resp.
• JP Nov. Lge. Retailers' Sales out at -2.5% y/y vs. -1.6% expected and -1.4% prior
• JP Nov. Industrial Production out at -2.6% m/m, -4.0% y/y vs. -0.8%/-2.0% expected and 2.2%/0.1% prior resp.

Upcoming Economic Calendar Highlights (All Times GMT)

• Sweden Household Lending (0830)
• Sweden Retail Sales (0830)
• Swiss KOF Leading Indicator (1030)

Lighter Volumes But Building Tensions Setting the Stage for M/T USD Strength?

US equities and the dollar ended mixed on Tuesday as volumes were light across asset classes with UK financial markets closed and many US traders off on extended holiday breaks. SEK and GBP outperformed versus USD in the G10 space while NZD and AUD underperformed against the greenback with losses of about -0.24% and -0.14%, respectively.

On the data front in the NY Tuesday a.m., US December Consumer Confidence rose to 64.5 versus expected 58.9 but the positive surprise was negated by the downside revision to November's figure 56 print to 55.2. Both the Dallas and Richmond December Fed Manufacturing Indexes also disappointed with prints of 3 vs. expected 5 and -3 vs. expected 4.8, respectively.

Wednesday's Asia-Pacific economic calendar only had Japan data on tap which mostly surprised to the downside:

• Nov. Job-To-Applicant Ratio at 0.69 vs. expected 0.68
• Nov. Jobless Rate as expected at 4.5%
• Nov. Household Spending fell -3.2% from year ago vs. expected -1.2%
• Japan Nov. Core Consumer Prices fell as expected by -0.2% y/y
• Tokyo Dec. Consumer Prices ex. food, energy fell -1.1% y/y vs. expected -1.0%
• Tokyo Dec. Overall Consumer Prices fell -0.4% vs. expected -0.6%.
• Japan Nov. Retail Sales fell -2.1% m/m vs. expected -0.5%; -2.3% y/y vs. expected 0%
• Japan Nov. Industrial Output fell -2.6% m/m vs. expected -0.8%; -4% y/y vs. expected -2%

The main focus, however, remains on Europe and all eyes will be on the outcome of Italy's 3 and 10 year bond auctions on Thursday (0500ET). Yields on 10 year Italian government debt managed to close below 7% but a poorly subscribed auction may see yields hurdle back above the key 7% mark on intensified debt contagion fears. We think this may pose the most immediate threat to EUR this week and would also likely result in concurrent broad-based USD strength.

Furthermore, USD may see increased safe haven bids in the days to weeks ahead from growing socio/geo-political tensions in Asia and the Middle East. While North Korea's Kim Jong Un may well have a smooth transition, rumors of a possible military power struggle and potential interest by China have made the rounds – the Kospi is down about -1% at the moment of writing.

Threats by Iran's vice president to cut off the Strait of Hormuz, a key oil shipping route, if sanctions on Iranian oil were further implemented boosted oil prices on Tuesday but perhaps even more alarming were threats that Iran was ready to hit Israel and US interests if need be. While the likelihood of a military confrontation doesn't seem likely at this juncture, further threats from Iran could dampen risk sentiments which in turn would likely provide USD some more support.

However, most G10-USD currencies are still trading within short term consolidation ranges although price action may be setting up for a continuation of USD strength in the longer term:

• AUD/USD still ranging from 1.0140 to 1.0180 with central banks rumored to be on the bid near range lows and downside pressure likely coming from broad street expectations for softer commodity prices at the start of Q1 2012.
•  
• NZD/USD broke below recent consolidation lows around the 0.7720 level but downside follow-through has been weak as converging support (trend-line from DEC 2011 lows & 200-hr SMA) around the 0.7680/0.7700 zone appears to be a more meaningful downside pivot; holiday range highs around 0.7750 still immediate resistance while the weekly closing break below the 100-wk sma suggests technical potential for m/t weakness.
•  
• GBP/USD better bid relative to its G10 peers but 1.5700 still capping upside with more meaningful resistance directly above around the 1.5750/75 zone which has halted all GBP upside attempts so far for the entirety of December. Key support can be found near the 200-hr sma around 1.5610. Trend-line support from the DEC 2011 lows, also neckline for a potential H&S continuation pattern (1hr charts) comes in around the 1.5600 figure; hourly closing breaks below project a measured move objective to the key 1.5350 daily pivot.
•  
• EUR/USD countercyclical consolidation also may be setting up potential H&S continuation pattern with the neckline coming in around 1.3050 (also the 200-hr sma); a move below would project a measured move objective towards the 2011 lows around 1.2860
•  
• USD/JPY testing trend-line support from the 75.50/55 lows at around 77.75/80 but its daily close below the tenkan line around 77.90/95 suggests further technical downside may be in store. Initial support likely comes in around the daily kijun line around 77.60 ahead of Ichimoku cloud covers around 77.40/45.

Price action in EM FX, however, was relatively more volatile with MXN underperforming and PLN outperforming against the US Dollar. Mexico's peso lost about -1.1% against the buck, seemingly a result of institutional position squaring in riskier currencies on lingering Euro-area debt concerns.

Poland's zloty gained around +1% vs. USD on speculation its central bank & the BGK (state run Bank Gospodarstwa Krajowego) would continue intervening directly in currency markets by selling EUR and USD. The concerted intervention efforts in Poland are being taken in order to keep its public debt as a percentage of GDP under 55% to avoid automatic fiscal tightening measures.

Overall, both G10 and EM FX still seem most sensitive to Euro-area developments and will likely make Thursday's 3&10yr Italian government bond auctions the main event in this final week of trading for 2011.

Sterling, a Year of Living Dangerously

Sterling will have a tightrope to walk during 2012 as the UK is buffeted by Euro-zone and global developments. Vital UK currency support, gained from an exodus of funds from the Euro area and interest by reserve managers, will be severely tested in the new year. The government’s economic strategy is hanging by a thread with very little room for manoeuvre on fiscal policy and the UK is at the mercy of global events. Only a further small-scale shock would leave the economy in serious danger which would also weaken Sterling. Without capital controls, the inward flow of funds could turn into a debilitating exodus. Currency levels, however, are all about relative performance and, with all major currency areas facing severe structural challenges, Sterling should be able to avoid severe damage.

The most likely outcome is that Sterling will weaken against the dollar with a slide to below 1.50 and potentially a move to the 1.45 area during the first half of 2012. If the Euro area remains intact, Sterling has the potential to advance to the 0.7850 area. If the Euro area splits, then Sterling will weaken very sharply towards parity against a new hard Euro.

There is no doubt that the economy deteriorated during the last few months of 2011. The actual survey and economic evidence was actually mixed and generally held up better than expected which offers some hope for the year ahead. What was striking was the degree of pessimism by the Bank of England. Their unease, bordering on fear, will certainly increase recession fears, although the over-riding factor is the uncertainty.
The UK fixed-income market had a remarkable run over the second half of 2011, culminating in benchmark 10-year yields falling to record lows of 2.00% as defensive flows poured into Sterling. Inflation will fall early in 2012 which will help underpin confidence. Given the UK and international debt profiles, the aggressive fiscal tightening will put the UK in a very strong position if there is sufficient global growth to allow the UK safe passage through the tightening phase. Currency independence will also prevent Sterling being trapped in the Euro area deflationary spiral.

There is, however, now a much higher risk that international conditions will conspire against the UK. The government has already had to raise its borrowing forecasts by £100bn over the next five years even before any second recession. The banking sector faces renewed stresses and any further bailout requirement would have a devastating impact on public finances.

Bond yields look to be very close to a one-way bet as it is very difficult to see them falling significantly further even with inflation falling. In this context, it will be much more difficult to attract overseas funds on valuation grounds.

If fears surrounding the Euro-zone economy increase then the UK outlook will continue to deteriorate. The UK has been broadly insulated from sovereign debt fears during 2011, but talk of credit-rating downgrades will intensify if the UK enters recession and it won’t just be the Bank of France calling for a downgrade to the AAA rating. A vicious cycle of capital outflows and weakening growth could expose Sterling to heavy selling.

Crude Oil Back above $100

U.S. Dollar Trading (USD) stocks finished unchanged in a lackluster session with little fresh news for traders to work with. Consumer Confidence picked up in December to 64.5 vs. 56 previously. October Case Shiller House prices fell -1.2% m/m though and this tempered some of positivity. Some concern emerged over threats from Iran to disrupt shipping in the Strait of Hormuz. Looking ahead, No data today
The Euro (EUR) range trading continued with little interest to move above 1.3100 or below 1.3000. Traders are waiting for Italian Bond Auctions later this week to see how demand fairs. EUR/CHF is holding above 1.2200 for now could edge higher if support continues to be found at the level.

The Japanese Yen (JPY) USD/JPY fell back to supports at Y78.80 with strong demand for the Yen across the board. EUR/JPY slipped back to Y101.6 but has support just below. The outlook is for more range trading around the Y78 level. UPDATE November Core CPI -0.2% y/y.

The Sterling (GBP) saw a sharp rally to 1.5700 going into Europe before paring back to 1.5650 and holding into the close. EUR/GBP finished under 0.8350 and is still trending lower but finding support. Stocks in the UK were closed so outside markets set direction yesterday. Stocks reopen today.

The Australian Dollar (AUD) kept to the same range as Monday with traders concerned about the Iran threat but positive about the US consumer confidence data. Stock markets will be closely watched this week with hopes still remaining of a year end rally.

Oil & Gold (XAU) Gold Broke below $1600 in a weak session for the precious metal which is struggling to hold onto gains in recent weeks. Oil surged above $100 on concerns Iran will block a major Shipping route if sanctioned.

WTI Oil Prices Move Above $100 on Iran War Games, CAD to Benefit?

Oil prices broke above the $100 a barrel level today, pushing above the resistance we saw in Friday's trading session.
The reason for the jump higher were rising tensions in the Middle East on the back of Iranian war games as well as an admission by Syria that they have cut their oil production as a result of sanctions by European countries.

From Financial Times: "Sufian Alao, Syrian oil minister, revealed over the weekend that Damascus had cut oil production to 260,000 barrels a day, down from a pre-crisis level of 380,000 b/d.
The Syrian oil disruption is relatively small, but oil traders are worried about the potential for a much larger outage involving Iran, the world's third-largest oil exporter. The European Union is discussing a potential oil embargo on Tehran and Iran has staged naval war games in the Strait of Hormuz."

Iranian War Games In Strait of Hormuz

The threat by European nations to impose an oil embargo on Iran has increased tensions and oil prices should remain supported as a result. The wargames by Iran will run for 10 days and started on Saturday.

From National Post: "Admiral Habibollah Sayyari, head of Iran's navy, said submarines, destroyers, missile-launching ships and attack boats will occupy a 2,000-kilometre stretch of sea from the Strait of Hormuz, at the mouth of the Persian Gulf, to the Gulf of Aden, near the entrance to the Red Sea…

Iran said the war games would be held in international waters…
Closing the Strait for just 30 days would send the price of crude racing up to US$300 to $500 a barrel, a level that would trigger global economic instability and cost the U.S. nearly US$75-billion in economic activity…

"Considering Washington's more general - and fundamental - interest in securing freedom of the seas, the U.S. Navy would almost be forced to respond aggressively to any attempt to close the Strait of Hormuz."

But Mr. Cordesman also warned "Iran could not ‘close the Gulf' for more than a few days to two weeks even if it was willing to sacrifice all of these assets, suffer massive retaliation, and potentially lose many of its own oil facilities and export revenues.""

Higher Oil Benefits Canadian Dollar

One currency that certainly has a chance to rally from higher oil is the Canadian dollar.
The USD/CAD has receded from the 1.0415 level on December 19th down to 1.0190 in today's trading, remaining below the 200 EMA in the hourly timeframe in using currently the 55 EMA (dark blue) as resistance. The pair trades at the 61.8% retracement of the 3670 pip upmove from December 8th to 19th, and a push lower opens up the 1.0130 and 1.0050 levels to the downside.

Any actual provocation with Iran and the US however would likely result in strong flows towards the USD as investors would seek safe-haven, but a gradual climb of oil on the back of tensions can favor the Loonie.
While price action in today's session was rather subdued and within the range we had seen to end last week, we have highlighted how the Canadian dollar may be able to start off the first quarter on a strong note if we have tentative risk on sentiment as well as growth divergence in North America - better-than-expected data from the US.

Banks Park LTRO Cash at ECB, Key Test as Italy to Sell 20B in Bonds This Week

LTRO Increases Credit to Banks by €210B

Last week we saw the ECB lending out to European banks and its largest refinancing operation in history. However if you look a little closer at the figures we see that it resulted in a net increase of around 200 tend to Europe

From ZeroHedge: "The first-ever 3-year liquidity operation by the ECB was an unqualified success. Banks bid for a greater-than-expected €489.2bn, making this the largest-ever single refinancing operation in the ECB's history.
However, this is not the net amount by which outstanding ECB open market operations have increased. Because banks reduced their use of the Main Refinancing Operation (MRO) by €123bn yesterday, and also the use of 3-month long-term refinancing operations (LTROs) by €111bn allotted today, the net increase is smaller.
Moreover, several banks made use of the possibility to swap out of the recent 12m LTRO that was allotted in October into the new 32-month facility (123 out of 181), to the tune of €46bn. So the net increase in outstanding open market operations is about €210b."

Banks can use this funds one of four ways:

1. Banks could shore up balance sheets as European banks need to raise around €115 billion in order to meet fresh capital requirements.
2. They could use this money to buy sovereign bonds, in effect conducting a carry trade by borrowing at 1% from the ECB and buying Italian or Spanish or other periphery debt that yields higher amounts and pocketing the difference. Having been burned by exposure to sovereign debt, the banks may be reluctant to follow this strategy.
3. They could use the money to lend to businesses and households - the key priority for the ECB which does not want to see austerity by governments coincide with a pullback in lending by banks which need to meet new capital requirements.
4. Banks could park the money back with the ECB at its deposit facility which pays 0.25% interest, which is actually a negative carry but it would mean banks have access to cash when needed - a piggy bank.

The action that banks take will have important impact on the health of the European banking sector as well as on the health of the economy. If they decide to lend money that could mitigate the impact on the European economy from the pullback in government spending. If they borrow the money and buy sovereign debt that can help keep yields in the periphery from rising to dangerous levels. However if they simply hoard the cash it may have a minimal impact, except it would help give banks more security in regards to their own funding needs.

Banks Park That Cash in ECB Deposit Facility

Coming out of the weekend it seems that banks have chosen to take the fourth option described above which is to park most of the funds with the ECB.

From Spiegel: "This week has seen the level of deposits at the ECB's overnight facility rise to close to €412 billion ($538.4 billion) — the greatest amount seen since the euro's introduction, and representing a single overnight increase on Monday of €65 billion.
Normally banks tend to lend any excess funds to each other. By doing so, they can make more money — especially given that interest rates at banks are currently twice as high as those offered by the ECB. But the interbank market has been disrupted for weeks now, prompting concerns that the credit crunch last seen after the collapse of Lehman Brothers has returned. European banks no longer trust each other because it is unclear to what extent individual banks are exposed to government bonds from countries hit by the debt crisis, and whether those institutions are in jeopardy. Instead, they are turning to the ECB as a safe haven for their money."

Here is a look at the ECB depost facility's usage via ZeroHedge:

Italy to Sell 20B This Week, Highlight in European Bond Markets

The key event this week therefore in European bond markets will be Italy attempting to sell about €20 billion of debt.

From Bloomberg: "German notes rose, pushing the rate on two-year notes to less than 0.2 percent for the first time, as investors sought the safest assets before Italy auctions as much as 20 billion euros ($26.2 billion) of debt.
Italy plans to sell 9 billion euros of 179-day bills and as much as 2.5 billion euros of zero-coupon notes due in 2013 tomorrow. It will offer bonds due between 2014 and 2022 on Dec. 29."

With thin liquidity we'll see what appetite there is for those bonds following the LTRO action by the ECB.

From CNBC: "The 10-year is the area where Italy has to rely more on foreign investors and it will be very tough to sell especially at this point in the year, so I expect further cheapening of the bond going into the auction," ING rate strategist Alessandro Giansanti said.
"The three-year would be easier to sell, there is some demand from the domestic investors. If they see really weak demand in the 10-year … they may sell more short-term (debt)."
"(The Italian auction) is the main event this week," one trader said. "There's almost no liquidity out there, (investors) are just getting their books ready for next year, it's going to be very thin all week.""

A drop in the yield that Italy has to pay would be a positive sign and we should be looking to see if we can get a better bid-to-cover ratio. However if we see higher yields and weaker demand that it shows that banks do not have any appetite for Italian bonds even after if it means positive carry trade as a result. Still, with liquidity thin we shouldn't give too much weight to the auction, though it may have an immediate impact on European markets and therefore the EUR/USD in this week's trading.

Morning Forex Fundamental

EUR

Standard & Poor's is expected to release its verdict on credit ratings for 15 euro zone countries in January, after putting them on credit watch December 6 for a possible cut in the absence of decisive action from European leaders.

"We have got an informal signal from Standard & Poor's that they will come only in January," said a government source on condition of anonymity because exchanges with the rating agency are confidential.
"In conversations we have had, they have let this be known if you read between the lines," he added.

USD

Economists expect home prices to decline at a slower pace in forthcoming months with prices reaching a bottom in the middle of 2012. Property prices declined 3.2 per cent in October, compared to the same period last year.
"We'll continue to see prices drop," said Mark Vitner, a senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. "The middle of 2012 is when we think prices will actually bottom."
"We need a higher level of confidence to get back to the traditional move-upstream or first-time buyer out of the rental," said Jeffrey Mezger, chief executive officer of KB Home.
"A lot of consumers are surprised, frankly, at how low home payments are compared to rent."

GBP

U.K. banks were closed on Monday in observance of Boxing Day.
U.K. stocks rose on Friday amid better-than-expected economic data from the world's largest economy. The benchmark FTSE 100 index gained 1.02%, or 55.73 points, to 5,512.70. The FTSE All-Share Index edged higher 0.98%, or 27.48 points, to 2,827.09.
"U.S. data is providing what markets have been looking for in terms of a wider economic improvement and rising employment," said Witold Bahrke, a senior strategist at PFA Pension A/S in Copenhagen.
Nationwide Building Society is to announce its month on month house price index on Friday. Economists expect house prices to rise 0.3 percent in December, after increasing 0.4 percent in November.

CHF

Most Swiss banks were closed on Monday in observance of Boxing Day.
Swiss stocks closed higher on Friday amid hopes the U.S. economy is gaining steam. The Swiss blue-chip index SMI, a measure of the largest and most actively traded companies, rose 0.97%, or 56.83 points, to 5,893.89. The broader Swiss Performance Index edged higher 0.90%, or 47.13 points, to 5,308.95.
"Recent positive economic data out of the U.S. have helped revive the markets," said Manish Singh, the London-based head of investment at Crossbridge Capital.

JPY

Japanese stocks edged higher on Monday after the U.S. Congress passed payroll tax extension. The Nikkei 225 gained 1.00%, or 84.18 points, to 8,479.34, while the broader Topix advanced 0.46%, or 3.32, to 726.44.
"The U.S. economic data is not bad on the whole," said Yoshinori Nagano, a senior strategist in Tokyo at Daiwa Asset Management Co. "Congress passed a two-month U.S. payroll tax cut extension, which reduced concerns in the market because investors had worried the end of the tax cut would likely weigh on January-March GDP."
Japan's Ministry of Economy, Trade and Industry is to announce its year on year retail sales on Wednesday. Economists expect the reading to increase 0.1 percent in November, compared to the same period last year.

What To Read Today

Europe

• The ECB allotted 489 billion euros in three year loans to 523 banks at the average rate of 1 percent on Wednesday, exceeding forecast of 293 billion euros.
• 26 EU member countries consider joining new treaty on deeper fiscal union, UK isolated; Merkel is "very pleased" with outcome of the summit.
• The ECB cut benchmark rate to 1% on December 8, but fell short of confirming it will buy EU member countries' bonds in unlimited quantities.

The euro: Still in casualty

http://www.bbc.co.uk/news/world-europe-16305731

It is a measure of the depth of the eurozone crisis that it is now identified as one of the defining stories of 2011, taking its place next to the Arab Spring.

ECB's Stark: IMF Cannot Be Used for Monetary Financing - Press

http://www.cnbc.com/id/45774361

Europe should not use the International Monetary Fund to go around the ban on central banks financing governments and current plans might breach that principle, European Central Bank Executive Board member Juergen Stark was quoted as saying on Friday.

USA

• The latest US macroeconomic data indicates that the national economic recovery is getting stronger; the number of Americans claiming for unemployment benefits fell to 364K while unemployment declined to 8.6% in November.
• Obama signed a spending bill of nearly $1 trillion on Saturday, averting collapse of federal government services; Congress approved a two-month extension of payroll tax break for 160 million U.S. employees on Friday.

U.S. stores hope "Mega Monday" led to brisk sales

http://www.reuters.com/article/2011/12/26/us-usa-retail-megamonday-idUSTRE7BP0HC20111226

Shoppers found a mixed bag of bargains and so-so deals on Monday, as a day off for many Americans lured some out for what was likely to be the third-busiest shopping day of the holiday season.

Obama calls for payroll tax cut to be extended 'without delay' as bill passes

http://www.guardian.co.uk/world/2011/dec/23/obama-payroll-tax-cuts-victory

President Barack Obama marked a rare political victory over Republican leaders in Congress – who bowed to White House demands on Friday for a short-term extension to tax reductions for working Americans – by calling for the measure to be applied to the rest of 2012 "without drama, without delay".

Asia & Pacific

• Japan's economy grew 1.4% in the third quarter 2011, while the exports fell for a second month in November as the global economy is cooling down; survey of Japanese manufacturers shows business conditions are deteriorating.
• China's industrial output contracted in December, intensifying worries the country might face hard economic landing next year whereas China's top officials guarantee growth will continue in 2012.

China to ease bank reserves soon, analysts say

http://www.marketwatch.com/story/china-to-ease-bank-reserves-soon-analysts-say-2011-12-26?link=MW_home_latest_news

Speculation is mounting that Beijing will further cut bank reserve requirement ratios, as inflationary pressure is easing while overall growth in the economy is slowing.

Intervention Failing as Yen Poised to Gain

http://www.bloomberg.com/news/2011-12-26/yen-intervention-failing-means-world-s-best-currency-poised-to-strengthen.html

There's been no better currency in 2011 than the yen and strategists forecast more gains, even as Japan promises to intervene again in foreign-exchange markets and expands the world's biggest debt burden.

BoJ Minutes Suggest No Funding Concerns For Japanese Financial Institutions

FX liquidity still feels thin today as the holiday season and lack of economic events leaves the market rather subdued. During the Asian session, Japan's latest monetary policy meeting minutes were released - both for the regular 15-16 Nov meeting, and the unscheduled 30 Nov meeting. The BoJ underlined that the Japanese banking sector was not struggling with funding issues themselves, but added that the possibility could not be ruled out. As a reminder, the BoJ took part in coordinated action along with a number of other global central banks to provide swap lines to financial institutions back on 30 Nov.

Risk sentiment has been somewhat lower during overnight trading hours, with Asian equity indices all lower on the day. The Nikkei is down -0.5% and Shanghai Composite trading lower by -1.1%. The Hang Seng along with a few other indices in the Asia-Pacific region remains closed for the holidays. Unsurprisingly, with so many European countries on public holidays and no market-moving news released, EURUSD is largely unchanged on the day at 1.3070 levels.

Coming up in today's session, the economic calendar is very light - especially during the European morning. In the afternoon, US data picks up somewhat with the release of December consumer confidence, the Richmond Fed manufacturing index, and Dallas Fed manufacturing activity survey.
 

Markets in Holiday Mode

With markets still caught in holiday mode, the lack of action in the currency markets today was certainly not surprising. The week between Christmas and the New Year is traditionally a quiet one in currencies, with thinned liquidity and range bound trading as many traders have already packed it all in until they start fresh in the New Year. Today in Asia was a prime example as we saw a skittish AUD/USD slip from 1.0165 to lows under 1.0140 on no news in particular. Conversely, the EUR/USD spent the session on a slow crawl higher as the pair moved from 1.3045 to eventual highs that overtook the 1.3075 level.

With a lack of data or news to trade on, most pairs were contained in monotonous ranges of 20 to 30 pips, with a quick blast higher in the yen at the tail end of the day the only real shocker of the day. While currencies were trapped in small ranges, spot gold, XAU/USD saw a large drop from $1609.00 to $1591.00 over the course of the session, moves attributed to the lack of participants in the metals markets.

Looking ahead be aware that both the UK and Canada will be out later in the day for a continuation of the long holiday weekend. As well, tomorrow in Japan we can look forward to a slew of data out of Japan including CPI, household spending, retail sales and preliminary industrial production.

Australian Dollar Set for Tough Year

The Australian dollar is likely to be dominated by global risk conditions for much of 2012 and looks set for a renewed decline at the start of the year. Asian economic doubts are set to intensify and financial sector de-leveraging remains an extremely important issue at a global level, both key factors which work against the Australian currency. Throughout the year, selling into strength looks to be the best approach as it heads towards the 0.82 area against the US dollar.

Bearish bets on the Chinese economy are hazardous at the best of times, especially given the opaque nature of data collection and reporting. It has also become extremely fashionable to look for bad news in the Chinese property sector as media stories of ghost towns multiply. It is, therefore, easy to gain a distorted impression. Nevertheless, alarm bells are ringing very clearly surrounding the housing sector, lending and the banking sector. There is also increasing stress surrounding local-government finance as bad-debts escalate.

Throughout history, is has proved impossible to engineer a soft landing from the size of credit boom seen in China since 2007. Maybe the Chinese leadership can defy the historical odds and guide the economy to a controlled slowdown, but it does not look an attractive bet. If China heads for a hard landing then the Asian dominoes will feel the full effect as regional demand slows and there will inevitably be an increase in trade tensions.

There is likely to be a further phase of deleveraging within the global banking sector which will also slow potential growth as lending is curtailed. All the BRIC economies are likely to face tough challenges during 2012, especially with Russia again facing increased political risk.

There will be an important negative impact on the Australian economy, especially if trade disputes increase and there is likely to be downward pressure on commodity prices. The Reserve Bank will be prepared to cut interest rates further which would also push the currency lower.

The domestic economy is unlikely to provide strong support for the currency with spending and investment growth set to slow as the housing sector remains under pressure with property levels still substantially above the long-term equilibrium level.

Working in the Australian dollar's favour will be the fact that interest rates in the G7 area will remain at rock-bottom levels during the year. The Federal Reserve, at this stage, is committed to keeping short-term rates below 0.25% throughout the year and there will be strong pressure for the ECB to cut rates again from 1.0% now. The lack of attractive alternatives and low G7 interest rates will certainly give the Australian dollar significant support at times. The currency will also be supported by Australia's AAA credit rating which will attract sovereign reserve managers as the number of AAA-rated countries is set to dwindle still further in 2012.