EUR Takes A Dive On Moody's Downgrade

More than 75% of the gains that the euro made during the first half of the North American trading session was erased when Moody's downgraded France. After the bell, the rating agency announced that it has cut France's sovereign-debt rating by one notch to Aa1 from AAA. According to their calculations, France no longer deserves to be apart of the AAA club and could be downgraded again because they remain on negative watch. Lets be clear, Moody's is NOT the first rating agency to strip France of their perfect AAA rating. Standard & Poor's cut France to AA+ more than 10 months ago and independent rating agency Egan-Jones believes the country only deserves to be BBB+. However the EUR/USD has still fallen sharply because the downgrade shines a light on Europe's problems and reminds investors that the two largest countries in the Euro zone are not immune to the stress in the region. Earlier this month, ECB President Draghi and Finance Minister Schaeuble expressed concerns about German growth and Monday, Moody's said France's resilience to future Euro shocks are diminishing in light of rising risks to economic growth caused by uncertainty in the euro area. They also believe that GDP growth assumptions of 0.8% in 2013 and 2.0% in 2014 is overly optimistic which is really disconcerting considering that 0.8% is extremely anemic growth.

The recent stability in the EUR/USD led many investors to believe that if Greece were to receive her next bailout payment then perhaps the risks in the Euro zone would start to diminish. Tuesday, Euro-area finance ministers are meeting in Brussels to discuss the disbursement of aid and even though many countries believe that a decision will be made, we are skeptical because the European Union and the IMF have yet to reach an agreement on key issues. One option would be a partial aid payment which could help boost the euro in the short term but hurt it in the long term because the can would be kicked further down the road. If no agreement is reached Tuesday, which is likely, and Moody's downgrade hangs over the euro, we could see the single currency trade back to its November lows. Even if there is a favorable outcome for Greece, Moody's decision to downgrade France serves as a harsh reminder that the next phase of weakness for the euro could come from significantly slower growth in Germany and France that could lead to even deeper recessions in some of the peripheral countries.

USD: Stronger U.S. Data Drives Recovery In Risk Appetite
The U.S. dollar ended the day lower against most of the major currencies. The Japanese Yen was the only currency that appreciated against the greenback but the gains were small and represents hesitation/consolidation ahead of the Bank of Japan's monetary policy announcement. Monday morning's U.S. economic reports were good and the S&P 500 rose by the most in two months. With the Thanksgiving holiday approaching this week, there is a general sense of optimism in the market. President Obama expressed confidence that Congress will come to a deal to avoid the fiscal cliff and investors are buying into it. There is not much in the way of market moving U.S. data but what we have seen so far is encouraging. Existing home sales rose 2.1% in the month of October, which was a surprise since economists had been looking for a second month of weaker sales. Low interest rates and stronger consumer confidence provided underlying support for the housing market and spurred the strongest level of confidence among homebuilders in six years. These numbers indicate that the housing market is improving but even if this strength continues, there cannot be broad based recovery until the economy gains momentum. Housing Starts and Building permits are due for release Tuesday and a decline is expected after a particularly strong increase in September. Don't expect much progress on the fiscal cliff this week because the House is now on recess until next week.

GBP: Shrugs Off Dovish Comments From BoE
The British pound ended the day lower against the euro and higher against the U.S. dollar. While this is an interesting week for the British pound, we won't have any market moving U.K. data until Wednesday. The Rightmove House Price report was the only piece of data released over the past 24 hours and according to the report, house prices fell 2.6% in the month of November. The decline may be discouraging but house prices can be volatile and according to the report, house prices in key areas such as central London continued to rise. Over the weekend, Bank of England monetary policy committee member Miles said more stimulus may be needed and there is scope for additional Quantitative Easing depending on how the headwinds holding back growth play out. He said the bank's Funding for Lending Scheme will have some positive impact as we go into next year, but if it turns out that not enough as been done, that the economy's going to stay in a recessionary state and that's going to drive inflation down, there is more we can do. We have not run out of ammunition. These dovish comments did not have a material impact on the British pound because Miles' warning hinges upon further instability in the Euro zone and right now investors are optimistic.

AUD In Play With RBA Minutes And Speech From Glenn Stevens
The rally in U.S. equities helped to drive the Australian, New Zealand and Canadian dollars higher against the greenback. The Reserve Bank of Australia will be releasing the minutes from its recent monetary policy meeting this evening and the tone will help set expectations for monetary policy in the coming months. Most investors and economists are not currently looking for the RBA to ease in December because when they last met, they cited higher inflationary pressures and a stronger recovery in China as reasons for why they opted to hold monetary policy steady. This would normally lead us to believe that the RBA minutes will be neutral with a tinge of optimism but the central bank also downgraded growth that month on weakness in the mining sector, so caution could still be warranted. Aside from the minutes, RBA Govenor Glenn Stevens will also be speaking and in many ways, his comments are even more important than the minutes because they may incorporate the central bank's reaction to the recent decline in global equities. We believe that the RBA is comfortable with the current level of monetary policy and if they are, the AUD/USD should rally. However if they are still concerned about the global economic outlook, AUD/USD could give up part of its recent gains. Meanwhile a sharp increase in service sector activity helped to keep NZD/USD supported. Service sector PMI rose to its highest level since November 2007, completely overshadowing the drop in producer prices. While the improvement in service sector activity makes us less discouraged about the outlook for New Zealand, it may not be enough to remove the risk of a rate cut from the RBNZ before the end of the year.

JPY: BoJ Not Expected To Ease In November
Tonight is a big night for Japan and the Yen is trading cautiously ahead of the Bank of Japan's monetary policy announcement. As we wrote this morning, we do not expect the BoJ to ease monetary policy. While the economy has deteriorated significantly since the last meeting and many local economists believe that recessionary conditions have returned, the central bank may feel that it is too soon to ease again having just increased asset purchases, introduced a new lending program and signed a joint statement with the government to end deflation in October. It takes time for stimulus to work its way down the economy and not many October economic reports have been released since the last meeting. The Bank of Japan and the Japanese Yen are under assault and Governor Shirakawa may choose to go out of his way to assert the central bank's independence. If the BoJ leaves monetary policy unchanged and makes no mention of future plans, the Yen could rally in relief. However if the BoJ downgrades its economic assessment like many expect and signal plans to ease right before the holidays in December, USD/JPY could extend its slide. One way or the other, more stimulus is on its way for Japan. The main source of Yen weakness is the realistic possibility of a major shift in monetary policy for the BoJ.

The dissolution of Parliament by Prime Minister Noda paves the way for a general election on December 16. On that day, we expect the DPJ to lose majority to the LDP which means former Prime Minister and current LDP leader Shinzo Abe will become the country's next leader. Abe has been calling for more aggressive measures to boost growth and inflation, starting with the BoJ. He demands the central bank ease aggressively and immediately by targeting a higher level of inflation, lower interest rates on reserves to zero or negative and make unlimited purchases of JGBs. In making these demands, he is effectively stripping away the central bank's independence, which may infuriate Shirakawa and other monetary policy officials because independence is a right under current BoJ law. Yet it has been a long time since the BoJ has been truly independent and we are seeing tighter involvement of the Japanese government day by day. Economics Minister Maehara's decision to attend this week's BoJ meeting is a sign that the government is increasing its pressure on the central bank.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management