The dollar weakened on Friday after risk appetite remained firm following reports that the ECB might work with the IMF to bailout struggling euro-zone countries. With the help of the IMF it would have the necessary funds to prop up even the largest euro-zone economy. Dovish commentary may actually have helped support the dollar slightly as it would have impacted negatively on risk appetite, as New York Fed President William Dudley continued to strike a dovish tone for monetary policy, saying the Fed would do “everything” to stimulate the economy as it faces “significant downside risks” which left the door open to further easing according to commentators. A rise in U.S treasury yields following investor’s preference for riskier assets helped the dollar recover against the yields sensitive yen, although it was still down overall on the day at the time of writing. Whilst the greenback performed badly on Friday it is expected to recover eventually as the crisis in the euro-zone appears far from over and likely to get worse, generating an increase in safe-haven demand.

   The euro rose on reports the ECB was seeking to work with the IMF in order to gain sufficient fire-power to be able to bailout any euro-zone economy, no matter how large. This led to a rally in risk appetite which supported the single currency. Commentary also helped the euro rise as Angela Merkel was reported as saying that “A number of technical details remain to be resolved,” to add more strength to the euro-zone’s bailout fund – however she diverged with David Cameron, advocating a softly-softly versus his more bazooka-like quick-fix preference. In Greece the 2012 budget was agreed with no more austerity and Venizelos saying this made Greece’s national debt “totally sustainable.” Talk of Spain seeking assistance from the EFSF helped the euro find support, and the ECB’s intervention in the bond markets led to the Italian 10-year falling to a more sustainable 6.680%. Overall the euro held up remarkably well as a lot of fear still stalked the markets and E.U yields still trended higher. On the data front German PPI rose by 0.2% vs 0.1% forecast; whilst YoY it rose 5.3% as expected. Italian Industrial Orders however fell by a larger than expected -8.3% when -6.0% had been expected.

   The pound gained but was hit by further speculation the BOE would increase its asset purchases, sparked by an interview with an MPC board member in the Financial Times in which he suggested a further tranche of easing might be introduced in February. BOE’s Martin Weale argued there was a “very strong case” to ease policy further and that the BOE might add to its purchases should the economy evolve as forecasts suggest. This weighed on sterling although global risk appetite helped to offset the damage after reports the ECB was in talks with the IMF over increasing its fire-power – to make it big enough to bailout even the strongest euro-zone country. Sterling also benefited from pre-weekend squaring of positions, although it did not rise against the euro which benefited from the rise in risk appetite more than the pound did. On the data front, meanwhile the docket was thin with nothing to report.

   The yen fell against riskier currencies and pared gains to finish the U.S session virtually flat versus the dollar. A rise in risk appetite after rumours the ECB was discussing cooperating with the IMF to increase its strength hit yen safe-haven demand heavily resulting in a fall versus the pound and the euro. A rise in U.S yields sparked by the increase in risk appetite may also have helped the dollar claw back losses from the comparatively lower-yielding yen. There were increased reports in the news of major corporations shifting their production overseas as the yen resumed its upward trajectory again: with Nissan and Panasonic named as two which would be transplanting work. Meanwhile there was also talk of a potential 38tr yen increase in the intervention war chest which the government was planning to ratify soon and what its tactics might be for using the money. Given large interventions would cause friction with G7 partners – since they are trying to persuade China to release its grip on the renminbi – the probability is that Japan will seek to influence the markets in less conspicuous more subtle ways. However, the threat of yen selling by ?the authorities in whichever form may be potent enough to keep heavy speculation at bay and moves on the traditionally volatile currency could become more muted as a result.

Analysis prepared by:

Joaquin Monfort
Forex4you analyst