Draghi Talks Euro Lower, Aso Lifts Yen

Official comments have injected volatility into the foreign exchange market. As we anticipated, Japanese officials pushed back against the seemingly free-fall in the yen sparked by the aggressive BOJ action and the diversification of the government pension funds. Finance Minister Aso expressed concern about the pace of the yen's decline. However, comments by Abe-adviser Hamada underscored that the direction was no objectionable and that JPY120 would be good for the Japanese economy. The dollar was pushed off a full yen to roughly JPY117.35 before finding a good bid.

In the European morning, at a banking conference in Frankfurt, the ECB's Draghi expressed a sense of urgency that heightens the risk of fresh action as early as next month. This pulled the rug from underneath the euro. The stabilization seen this week ended abruptly, and the euro dropped from near $1.26, which it had tested over the past two sessions, to new lows for the week near $1.2420.

Draghi said inflation has to be lifted as fast as possible and that the ECB would widen its asset purchase plan to achieve this, if necessary. It seems clear that he thinks it is necessary. Previously, ECB officials had intimated that with covered bond purchases finding traction at more than 2 bln euro a week, the ABS program just about to begin, and the second TLTRO in a few weeks, which promises to be more used than the first offering, there was a sense of waiting to see the impact. However, Draghi's comments hold out the possibility that the ECB will announce an increase in the range of assets it at the next meeting, at which the staff macro forecasts are likely to be cut again.

The Bundesbank's Weidmann is also speaking at same banking conference. He is not displaying the same sense of urgency as Draghi. Instead, he is talking about other long-term reforms, such as reducing the tax incentives that favor debt over equity, and he pushes one of his hobby horses, changing the zero-risk rating of sovereign bonds and/or other measures when banks hold a substantial amount of capital in government bonds.

Unwinding short-yen crosses against the euro and sterling may also be taking a toll today. The euro is nearly 2% of yesterday's high against the yen near JPY149. Sterling has fared somewhat better. It was above JPY186 yesterday and now is near JPY184.35.

Although it does not appear to be a market factor today, we note that UKIP picked up another seat. Mark Reckless, who switched from the Tories to UKIP, held on to his seat in Rochester and Strood seat. The UK will hold national elections next May. The Tories and Labour are in a virtual draw while UKIP is in a distant third, but above the Lid Dems. The other wrinkle in the plot is that the Scottish National Party is likely to replace the bulk of Labour seats in Scotland. The SNP is to the left of Labour.

Meanwhile, SNB officials have reiterated their commitment to the defending the CHF1.20 level. There are some banks that claim that the price action suggests the Swiss National Bank has engaged in material intervention, but this is a contested claim. The verbal intervention looks sufficient to have steadied the cross. We could have expected material intervention to have caused a larger market reaction. The euro has risen from CHF1.2009 on Wednesday to CHF1.2033 today. It is a nine-day high and is near the 20-day average (~CHF1.2035), above which it has not been since October 14. With the prospects of more ECB action and the pending Swiss referendum, it may be difficult to engineer a sustained recovery in the euro against the franc.

China surprised many today’s by announced a rate cut. It has been providing extra liquidity in a targeted fashion to some banks, and this seemed to be its preferred course of action. It cut the one-year deposit rate by 25 bp and cut the lending rate by 40 bp. With a number of IPOs to hit the market next week, squeezing short-term interest rates higher, many thought the continued injections of liquidity would be sufficient. However, the rate cut may reflect greater concern about the trajectory of the economy.

The Australian dollar (and the New Zealand dollar) jumped in response to the PBOC move. Several emerging market currencies, including the South African rand, also moved higher in reaction to the unexpected Chinese rate cut. Some commodities, including copper and oil also responded favorably to the surprise move.

Activity is likely to slow in the North American session. The only US release is the Kansas City Fed survey, not exactly a market mover, even in the best of times. Recall yesterday the Philly Fed survey jumped so much that many suspect a statistical fluke (40.8 from 20.7) and existing home sales rose to their best level of the year. Canada reports October CPI figures. The core rate is expected to be unchanged at 2.1% while the headline rate is expected to tick up to 2.1% from 2.0%.