Stalled US budget talks lift dollar

The yen slipped close to a 20-month low against the US dollar at the start of the week after newly elected Prime Minister Shinzo Abe increased pressure on the Bank of Japan to boost its inflation target in its meeting next month.

The greenback is likely to continue to gain support in the near term- Emman Xuereb

The Nipponese currency and the US dollar rose on Friday, as forex investors trimmed bets on riskier assets and favoured safe haven currencies as US lawmakers struggle over a budget deal to avert automatic spending cuts and tax increases.

Late last Thursday, markets slumped and the euro retreated from an eight-month high against the dollar after the Republican Speaker of the US House of Representatives, John Boehner, failed to garner enough support from his own party for his bill, dubbed Plan B.

Boehner’s Plan B, which proposed raising taxes on those earning $1 million or more a year was rejected by conservative Republicans who are adamantly against any tax increases. This fuelled concern on whether Washington will strike a deal on time and avoid falling over the fiscal cliff. In a news conference on Friday, Boehner said it was now in President Barack Obama’s hands and the Democrats to reach a deal before year end.

Financial markets are in a state of uncertainty over $600 billion of spending cuts and tax hikes that will kick in the New Year unless a deal is reached, which threaten to hurt the economy and send the world’s largest economy into another recession. Lawmakers and President Obama have abandoned talks to prevent the fiscal cliff until after Christmas.

The breakdown in talks has benefitted the US dollar, as traders fled to refuge, and weighed in on riskier currencies such as the euro and Australian dollar. EUR/USD fell to 1.3159 on Friday, from an eight-month high of 1.3308 hit on Wednesday. The greenback is likely to continue to gain support in the near-term as long as uncertainty over the fiscal cliff remain.

Risk appetite did not rebound, even despite stronger than expected data from the US at the end of last week, which showed the economy grew at a faster pace than initial forecasts in the third quarter and also higher consumer spending.

The Commerce Department reported on Friday that the final GDP reading for Q3 jumped to 3.1 per cent from a previous estimate for 2.7 per cent. Spending by consumers hit a three-year high in November, as personal income rose and consumers brushed aside concerns over higher taxes next year and purchased more.

The single currency also fell from 16-month highs against the yen on Friday. EUR/JPY dropped to 110.63 from its peak by 112.50 on December 19. The pair opened this week higher however, as the yen slipped across the board. The Japanese yen was hurt by expectations for more aggressive easing as incoming premier stepped up calls on the Central Bank to act.

Speaking on television, Prime Minister Abe called on the BoJ to adopt a two per cent inflation target and said he was ready to revise a law that guarantees the Central Bank’s independence if his demands for bolder steps to fight deflation are not met. He stopped short of giving a precise level for the yen against the dollar but hinted that there is a “difference whether the yen is at 80, or at 90 to the dollar.”

USD/JPY rose to 84.49, within sight of a 20-month peak hit last week by 84.62. Forex traders were eyeing a break above its 200-week moving average at 85.05 to sustain more gains towards a test of 2011 high by 85.53.

After this weekend’s remarks, analysts considered how much scope the BoJ still had to ease further. Studies showed that the BoJ’s holdings of Japanese Government Bond amount to only 12.1 per cent of the total issuance and this was much smaller than the Federal Reserve’s holdings in the US Treasury Market and the Bank of England’s presence in the Gilt market. Undoubtedly, if the BoJ adopts an inflation target of two per cent in its next meeting on January 22, the pace of its bond-buying will have to accelerate in order to give the new target credibility.

Upcoming FX key events
Today: US consumer confidence and US new home sales.
Tomorrow: French GDP, US Chicago PMI and US Pending home sales.

Technical key points
EUR/USD is bullish, target 1.3280, key reversal point 1.2600.
EUR/GBP is bullish target 0.8220, key reversal point 0.7950.
USD/JPY is bullish, target 85.50, key reversal point 79.25.
GBP/USD is bullish, target 1.6300, key reversal point 1.5800.
USD/CHF is neutral.
AUD/USD is neutral.
NZD/USD is neutral.

I wish you and your families all the very best for the festive season, and a happy and prosperous new year.

trading@rtfx.com

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Emman Xuereb is a trader at RTFX Ltd.