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Bank of Japan stays on hold, while Italy battles to save its banks

Yesterday proved to be a fairly quiet day for Europe’s markets as the wind down for Christmas began in earnest, while US markets also struggled to rally with any conviction, finishing slightly higher.

The tragic events in Turkey, Berlin and Switzerland don't appear to have had any significant effect on financial markets for now but they could well influence the political calculus in Europe next year given the elections in the Netherlands, France and Germany, as concerns about terrorism influence the way people vote with respect to the status quo.

The US dollar has continued to remain resilient moving back above the 103.00 level on the US dollar index after Friday’s sell off, on the back of continued hawkish chatter about the prospects for several rate rises into 2017.

This was reinforced over the weekend by Richmond Fed President Jeffery Lacker in an almost identical echoing of events this time last year. Last year a number of Fed officials including Mr Lacker also sounded off about the prospects of much tighter policy only to spend most of the year procrastinating before finally delivering just the one rise in rates.

While Mr Lacker’s views are important, they aren’t generally representative of the FOMC and he doesn’t have a vote until 2018 in any case. With three new Fed Presidents due to take up their voting rights in 2017 the dovish or hawkish bias of Messrs Kashkari of the Minneapolis Fed, Kaplan of the Dallas Fed and Harker of the Philadelphia Fed still remain an unknown quantity.

Nevertheless the bullishness of Fed chair Janet Yellen’s comments to students at an event in Baltimore yesterday about the health of the US jobs market would appear to suggest that more rate rises could well be on the way in fairly short order.

There was one outlier to yesterday’s US dollar strength with the Japanese yen pushing sharply higher, though this was likely due to the fact that traders were adjusting their positions ahead of this morning’s Bank of Japan rate meeting, which saw the Japanese central bank leave rates unchanged. The bank also upgraded its economic outlook, noting the improvement in the economy.

This shouldn’t have been a surprise to most people given recent yen weakness which has come as a welcome relief to Japanese policymakers, after several failed attempts this year to weaken the yen. Even so the yen still remains above the levels it was when the Bank of Japan first pushed rates into negative territory in January, and reinforcing the reality that the only way the yen is likely to weaken further is as a result of future US policy moves.

Most of the focus yesterday was on the banking sector and events in Italy with respect to a final attempt by Monte dei Paschi di Siena to raise the €5bn needed to finance a private sector restructuring program. The omens don’t appear to look too promising with respect to obtaining buy in from overseas, as well as retail investors.

After all when Quaestio Capital Management, who run Atlante the country’s very own bailout fund expresses concerns about the structure of certain parts of the deal, then it’s not overly surprising that no-one else has much appetite to participate.

As the clock ticks down towards the end of year deadline, Italian politicians already appear ready to put into practice Plan B, and take steps to inject €20bn of capital into the banks, boosting Italy’s already high government debt level in the process. 

EUR/USD – while below the 1.0520 level the risk remains that we move through last week’s multi-year low at 1.0365 towards parity. To delay this prospect we would need to see a move back through the 1.0520 area towards the 1.0700 area.

GBP/USD – recent weakness has seen us slip back towards 1.2355 but it would need to see a move below 1.2300 to argue for a move back towards the 1.2100 area. Odds still favour a return towards the highs last week at 1.2670.

EUR/GBP – continues to find support just above the 200 day MA at 0.8310, which remains a key level. A break below argues for a move towards 0.8230. We need to see a recovery back through 0.8480 to stabilise.

USD/JPY – continues to drive higher towards the 120.00 level, and likely to continue to do so while above the 115.60 level. A move back below 115.60 would then suggest a move back towards 114.00.

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