It has been an extremely busy morning in the foreign exchange market but in a very good way because we are finally seeing global policy coordination. Central banks around the world have flooded the markets with liquidity by cutting interest rates on dollar swaps, extending swap authorization to Feb 2013 and setting up bilateral liquidity swaps in other currencies. The goal of the Fed, ECB, BoJ, BoE, SNB and BoC is to ensure that there are enough dollars in the market at a cheap rate in the event that there is another liquidity squeeze that makes it difficult foreign central banks to deliver U.S. dollar funding to lenders in their regions. This morning's coordinated action also implies that the central banks feel conditions are much worse than they would otherwise lead us to believe which is why more liquidity is needed immediately. The markets are always relieved to see central banks put up a unified front especially on the heels of a similar increase in liquidity from China. The EUR/USD and other currencies have soared following this morning's announcements and barring any negative news, equities should trade sharply higher today with currencies holding onto most of their gains. The influx of liquidity is a welcome distraction from the troubles in Europe. It does not remove the need for structural reforms and more commitment from European nations but it eases conditions in the financial markets and shows that central banks are willing to work together to avoid another financial catastrophe. Does it remove the downside risk in the euro? No but the risk rally could last for a few days.
China Cuts RRR
Early this morning, the Chinese government rode in like a white knight cutting their reserve ratio requirements and sending currencies and equities sharply higher. For the past few years, China has carried the weight of global growth on their shoulders and today's decision to increase liquidity will bring relief to China and the rest of the world. Having traded heavy during the early European session, all of the major currencies soared after China's announcement while equity futures turned positive. Easier monetary policy in China does not solve Europe's fiscal troubles but it reduces the chance of a steep slowdown for countries like Australia and New Zealand. One of the greatest risks for the global economy in 2012 is a hard landing by China but thankfully today's decision shows that the Chinese government is taking steps to cushion the economy even if it comes at the expense of higher inflation. However with consumer prices cooling to 4.4 percent in October, price pressures have eased, so the decision to loosen monetary policy wasn't that difficult.
German Yields Turned Negative
Another dynamic worth watching is the one in German bond yields. One year German bond yields turned negative this morning which is a big deal because it means investors will receive less money than they paid for bonds when they mature. The reason why short dated German bond yields turned negative is because investors expect the ECB to cut interest rates in the near future. There were reports this morning citing unnamed ECB sources that the central bank is open to more rate cuts which really should not surprise anyone because the ECB is one of the very few agencies still able to support the Eurozone economy. Cutting interest rates to lower yields is a much easier decision than lending to the IMF or taking greater role in the European crisis. More rate cuts are inevitable especially if the Eurozone falls into recession next year. The Eurogroup meeting yielded very little outside of the EU's commitment to release the next tranche of aid to Greece. We now turn to the ECOFIN meeting for any market moving headlines but once again, we do not expect any major announcements until the EU Summit next week.
ADP Points to Strong NFPs
Aside from the Finance Ministers meetings in Europe, the other big event risk this week is the U.S. non-farm payrolls report. According to this morning's leading indicators for NFPs, there are many reasons to believe that the labor market improved in November. Challenger Grey & Christmas reported a 13 percent drop in layoffs yoy which was the steepest decline in 7 months. According to the ADP employment change report, U.S. companies added 206k workers to their payrolls last month, compared to 130k in October. For the past few weeks, jobless claims have also been less than 400k so even though ADP is not the best leading indicator for NFPs, the message is consistent because all signs point to greater job growth in November. More U.S. data will be released later today including Chicago PMI, Pending Home Sales and the Fed's Beige Book report. These releases are important but their impact on the dollar should be limited.
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