Euro To Extend Rally As EU Boosts Firewall To EUR 800B

The major theme last week was buy European majors, sell commodity currencies. The euro was firm on anticipation of the finance ministers meeting during the weekend and on expectation that there would be a final agreement on boosting the firepower of euro zone's bailout funds. Such expectation was fulfilled as EU finance ministers concluded the meeting by raising the ceiling of the combined lending power of ESM and EFSF to EUR 800b. On the other hand, commodity currencies, in particular aussie, was pressured on concern of slow down in China. US dollar was mixed as equities consolidated while treasury yield dipped for most of the week. Fiscal year-end repatriation balanced selling pressure in the Japanese yen and most yen crosses were stuck in range last week.

Our view on long European/commodity crosses was correct last week as as GBP/AUD, AUD/CHF and EUR/AUD occupied the top three positions in the top movers table. The bias is still there and we'd continue to favor stronger rise in EUR/AUD and GBP/AUD this week. In particular, EUR/AUD could break through 1.3 psychological level as reaction to the euro zone finance meeting news. Buying in EUR/AUD could intensify if the official Chinese manufacturing PMI to be released on Sunday dipped below 50. Though, we'll hold back on this view if the Chinese data beat expectation and would assess the outlook again after the week starts.

We also mentioned last week that we favored short in commodity/yen crosses. Such a strategy wasn't fruitful last week as repatriation buy in yen was not strong enough. We anticipated a slightly deeper pullback in yen crosses but that didn't happen. Indeed, the tide seemed to be turning to yen shorts against. Technically, we should note that most yen crosses seemed to have completed a three wave consolidation on Thursday or Friday and we'd possibly likely seen upside breakout this week. In addition, we should note the strong rebound in US treasury yield on Friday, which could also mark completion of recent pull back.

2.3% in 10 year US yield will be watched this week and if broken, stronger selloff in the Japanese yen would likely be seen. Anything other than commodity currencies against yen would be favored. That is, we would prefer long in USD/JPY, EUR/JPY and GBP/JPY. Though, considering the above strategy of long EUR/AUD, GBP/AUD etc., we slightly prefer long in USD/JPY this week as a hedge.

After the meeting in Copenhagen, euro zone finance ministers have agreed to mobilize an "overall firewall" of approximately EUR 800b, more than USD 1T. The detail of the program is that before July 2012, EFSF is the main instrument. After July 2012, ESM is the main instrument and EFSF will only continue to program that has already started. But during the the transitional period between July 2012 and mid-2013, EFSF can still engage in new programs to "ensure a full fresh lending capacity" of EUR 500m. And the overall ceiling of ESM/EFSF will be raised to EUR 700b even after mid-2013, as programs started by then would continue. In addition to the mentioned EUR 700b, EUR 59b out of EFSF and EUR 53b out of the bilateral Greek loan facility has already be paid. So altogether, the total is around EUR 800b.

Besides, EU finance ministers also agreed to accelerate and make available the paid-in capital of the ESM. Two tranches of capital will be paid in 2012, one in July and one by October. Another two tranches will be paid in 2013 and the fourth tranche will be paid in 1H 2014. And to maintain a 15 ratio between the paid-in capital and outstanding amount of EMS issuances, the paid-in could be further accelerated.

Also, euro zone finance ministers pledged an additional EUR 150b bilateral contributions to the IMF. IMF chief, Lagarde welcomed the decisions to "strengthen the European firewall. And EU ministers now urged IMF to increase its resources by raising as much as $ 600b in April in Washington. ECB Vice President Vitor Constancio played down the significance of raising the IMF warchest to euro zone but empathized that it's "not a specific fund or specific account for Europe" but "a recognition that in general for the world economy the IMF needs to have more resources". However, it's known that BRICS countries would only support increase in IMF resources if they are give more say. So such political development would be watched in the coming weeks.