USD Off Against All But One Major Currency

The U.S. dollar traded lower against all of the major currencies with the exception of the Swiss Franc. U.S. equities held steady despite President Obama's flat out rejection of any deal from the Republicans that does not involve an increase in tax rates on the wealthy. House Speaker John Boehner fired back by saying that they have presented a plan that can pass both the House and Senate while Obama's plan wouldn't pass either. The clock continues to tick and unfortunately we haven't gotten any closer to a Fiscal Cliff deal but based on the price action of the financial markets, investors are not overly concerned because a benign deal that will avoid an immediate shock to the economy but drag the talks into 2013 is likely.

• Wednesday's Data

In the meantime, as Fiscal Cliff concerns hover in the background, the focus will begin to shift to the U.S. labor with the release of ADP and ISM Non-manufacturing numbers on Wednesday. Everyone realizes that the data will distorted by Hurricane Sandy effects and Fiscal Cliff concerns but a sharp upward or downward surprise could still set expectations for next week's monetary policy announcements. If the ADP report shows very weak job growth or service sector activity expands at a slower pace, USD/JPY could extend its losses as investors price in more aggressive monetary easing from the Federal Reserve. If these leading indicators for non-farm payrolls surprise to the upside or do not decline as much as economists fear, we could see a relief rally in USD/JPY. A number of Fed officials believe that additional asset purchases were necessary after Operation Twist ends this year and comments from policymakers suggests that we could also get more support for tying interest rates to a piece of economic data like the unemployment rate.

EUR: The Relentless Rally Continues
The euro continued to power higher against the U.S. dollar. Over the past 12 trading days, we have only seen one down day in EUR/USD and Tuesday, the currency climbed to a fresh six-week high. European stocks and bond yields ended virtually unchanged and despite a larger 0.1% increase in Euro zone producer prices, inflationary pressures in region remain muted. So why is the euro so strong? We discuss all of the reasons Why Investors Are Buying Europe in our special report but it boils down to the fact that the additional aid provided to Greece and Spain reduced the risk of Europe's sovereign debt crisis bubbling over again and of course, EUR/CHF buying. As long there isn't a sharp increase in European bond yields, the euro will able to shrug off all bad news including rumors of further downgrades by Moody's and warnings of weaker growth made by policymakers in countries like Spain. However, yields could rise again at any time if investors start to shun European assets. EU Finance Ministers continued to bump heads on banking supervision as they try to reach an agreement on the scope of the supervision and the role on non Euro zone EU nations. The single banking supervisor is critical in safeguarding the region from future crises and needs to be implemented as soon as possible.

• Wednesday's Data

Final Euro zone PMI Services and October retail sales numbers will be released on Wednesday and the data will most likely show more weakness in the European economy. EUR/CHF extended its gains as UBS joins Credit Suisse in applying negative rates to banks. Swiss banks have finally decided to throw in the towel and punish their r banking counterparties by charging them interest for holding their franc deposits (negative interest rates apply only to banks and not individuals). The goal is to make Francs less attractive relative to other currencies and based on the price action in EUR/CHF, their efforts are paying off.

GBP: Why Osborne's Autumn Statement Could Kill GBP Rally
The British pound ended the day unchanged against the greenback and lower against the euro ahead of U.K. Chancellor Osborne's Autumn Statement. This speech is important because it is one of two major statements made by the Treasury each year. Wednesday, Chancellor Osborne will share the government's latest economic and fiscal forecasts and it is widely believed that he will cut growth forecasts and admit deficit reduction targets will be missed. Tuesday morning, the U.K. government announced five billion pounds in extra spending on schools, science and transportation over the next three years. The money will come from cuts in administration costs across the public sector that could involve significant job losses for government workers. The goal is to reduce "unnecessary spending" and to apply those savings to infrastructure projects that will generate growth. The Chancellor will also be forced to admit that he will need to cut spending for a longer period of time. Depending on his overall level of dovishness, the amount that GDP growth is reduced and the new fiscal targets, the GBP/USD could be subject to significant volatility. More specifically, if Chancellor Osborne's new projections are bearish enough, it could kill the rally in the British pound. The PMI report may provide some support if service sector activity sees an improvement like the manufacturing sector but even so, the Autumn statement will be more important.

NZD: Economic Weakness Warrants Renewed Dovishness
Monetary policy announcements have and will continue to be the big focus for the commodity currencies. Tuesday morning, the Bank of Canada left interest rates unchanged at 1% for the 18th consecutive monetary policy meeting, sending the CAD sharply higher. The last time the BoC moved on interest rates was in September 2010 when they raised rates by 25bp to its current levels. Despite slowing growth and soft consumer spending, the Bank of Canada held onto its hawkish bias. The lack of progress on the Fiscal Cliff gave the central bank very little motivation to shift to neutral especially since Governor Carney is distracted by preparing for his departure from the BoC and his new job as the head of the Bank of England. The central bank attributed part of Q3 weakness to energy disruptions and a strong currency and said it is too soon to know if the housing slowdown will last. With only a "small degree of slack" in the economy and growth expected to pick up through 2013, the BoC felt higher rates will likely be needed over time. Concerns about the U.S. Fiscal Cliff appeared in both the Bank of Canada and Reserve Bank of Australia monetary policy statements. The Australian dollar has soared despite the Reserve Bank of Australia's 25bp rate hike. While the RBA was worried about the outlook for global growth, it maintained a neutral tone, providing no hints about its bias to ease again next year.

On Wednesday afternoon, the Reserve Bank of New Zealand will hold its on own meeting. Since the last central bank announcement, we have seen an increase in the unemployment rate, a decline in retail sales, softer inflationary pressures, and a steadily wide trade deficit. By all counts, the RBNZ should be dovish, especially given the deterioration in Australian data. However, this is only the second monetary policy meeting for Graeme Wheeler and so he may not be in a rush to adopt a dovish monetary policy stance. The RBNZ is expected to leave rates unchanged but if they are dovish and talk about the possibility of future rate cuts, the NZD/USD may decline.

JPY: BoJ Easing Measures Lead To Wider Monetary Base
The Japanese Yen rallied against all major currencies except for the Australian dollar. There was no market moving data from Japan but there was some good second tier data and we believe that the strength of the Yen reflects profit taking on long USD/JPY positions. According to the Ministry of Labor, average wages in Japan increased in October. Total cash earnings rose by 0.2% year to year after a 1.5% decrease in September. Also the Bank of Japan announced that the monetary base increased 5% in November, which means that more money is in circulation thanks to the Bank of Japan's easing measures. The Nikkei 225 fell 25.72 points (0.27%) overnight.

With continued concerns about the U.S. fiscal cliff, investors are seeking out the safe haven currency but demand is limited because of political uncertainty. General elections will be in 1.5 weeks and the outcome could shift the landscape of fiscal and monetary policy. The Bank of Japan also came to an agreement with the Reserve Bank of India on a currency swap against the dollar for up to $15 billion for three years. The Yen and Rupee has been experiencing some turmoil as a result of euro zone uncertainty thus adding pressures and liquidity difficulties. The swap line will help provide liquidity and strengthen the currencies. The Reserve Bank of India stated, The arrangement aims at addressing short-term liquidity difficulties and supplementing the existing international financial arrangements, as one of the efforts in strengthening mutual cooperation between Japan and India.

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