Yen Crosses Retreat On Profit Taking, EUR/CHF Stays Strong

Yen crosses weakened mildly in Asian session today on profit taking, following retreat in equities. The Japanese yen is also weighed down mildly by comments from Japanese Economics Minister Amari, who said that excessive weakness in yen could "cause a spike in import prices." And while it benefits exports, it would have "harmful effects on people's livelihoods."

It now looks like the overstretched yen crosses are losing upside momentum and needs to consolidate recent sharp rise. Nonetheless, there are strong expectation that BoJ would expand its easing program next week and double the inflation target to 2%. And there are risks that BoJ could surprise the markets by doing more. The current retreat in yen crosses is generally viewed as consolidative only and there is no change in the near-term bullish outlook.

While the euro turned sideway against the dollar and retreats against the yen, it remains strong against the Swiss franc. Indeed, EUR/CHF jumped further to as high as 1.2384 so far today and the recent rally is set to extend to 1.24 level. While there was not much fresh news on the pair, it's believed that markets are starting to unwind the so-called "eurozone breakup" trades as the new year started as peripheral yields has largely stabilized since ECB's OMT announce last year.

The solid Spanish bond auction earlier this month was also gave investor confidence a strong boost. News from the eurozone this week was so far positive. S&P raised outlook on both Luxembourg and Finland to stable, from negative, and affirmed both countries' AAA rating. The Netherlands' negative outlook on AAA rating was maintained.

In the US, Fed Chairman Bernanke said that while there are some positives sing of improvements in the economy, "there is still quite a ways to go." "Things are moving" even though not as fast as the Fed would like to see. He also noted that quantitative easing is having positive effects on bringing longer-term rates down "pretty significantly" and is an "effective tool."

Regarding inflation, he said that he didn't see much evidence of that and expressed his confidence that the Fed has all the tools to "undo our monetary policy stimulus.... before inflation becomes a problem." Overall, Bernanke's comment didn't change the expectation that Fed wouldn't exit from its policy easing until at least the end of 2013.

Regarding the so called debt ceiling issue, Bernanke urged Congress to raise the ceiling to "avoid a situation where our government doesn't pay its bills." And, "we're not out of the woods because we are approaching a number of other fiscal critical watersheds coming up." He also said "the way to address it is to have a sensible plan for spending and a sensible plan for revenue."

US President Obama said criticized that "to even entertain the idea of this happening, of the United States of America not paying its bills, it is irresponsible, it is absurd." And Obama noted that "while I'm willing to compromise and find common ground over how to reduce our deficits, America cannot afford another debate with this Congress about whether or not they should pay the bills they've already racked up."

Atlanta Fed Lockhart said yesterday that Fed's open-ended QE "does not mean without bound." And he warned that "growth of the Fed's balance sheet could have longer-term consequences that are worrisome." He noted that "there is a risk, given the Fed's cumulative share of the Treasury and MBS markets, that at some point securities purchases could have adverse effects on market functioning and financial stability." And, "the Federal Reserve's net income and its remittances to the Treasury could be significantly affected during the period of policy normalization."

Looking ahead, inflation data will be the main focus in European session as UK will release both PPI and CPI data. CPI is expected to be unchanged at 2.7% yoy in December. A number of important economic data will also be released from US, including Empire State manufacturing, retail sales and PPI.