The lack of U.S. economic data this morning has barely been noticed by investors as the weekend events continue to capture the attention of traders around the world. As a result, the U.S. dollar has taken a backseat to country specific news with a surprise EU package driving European currencies higher while lower oil prices and Asia-Pac risk aversion drove the commodity currencies lower. The Yen may be unchanged but this price action masks a significant amount of intraday volatility. For the next 24 hours, the focus will be on Japan and Europe, but by Tuesday morning, investors will shift their focus back to the U.S, where the Federal Reserve is scheduled to meet on monetary policy.
The Bank of Japan has wasted no time responding to the earthquake by increasing monetary stimulus. Last night, the BoJ boosted its asset purchase program by JPY5 Trillion to JPY40 trillion, or 1 percent of GDP. The central bank's goal was to deliver swift and strong support to the Japanese economy by increasing liquidity and preventing an environmental / humanitarian / social crisis from turning into an economic one. This of course may be difficult to avoid because nuclear power plants have begun to melt down, creating a major power problem for parts of Japan. Shipping and refining have also been completely shut down the quake, paralyzing key industries in Japan. The Yen sold off initially in anticipation of the BoJ's announcement but repatriation flows eventually forced the currency to give up earlier gains.
In Europe, EU leaders surprised the market by reaching an agreement to expand the European Financial Stability Mechanism (EFSF) to EUR440 billion and to allow the purchase of bonds directly from individual countries which effectively gives the region a stronger ability to handle future crises. As a result, Portuguese and Spanish sovereign debt spreads have narrowed while 10 year UK Gilt/Bund spreads reached its tightest level since 2009. The reason why this deal was so bullish for the euro is because no one expected EU leaders to reach an agreement, let alone one with this many details. More specifics have to be decided on for the Summit at the end of the month, but the initial outline has been laid out, giving investors hope that the sovereign debt crisis could finally come to an end. Although we are bullish euros, the stress tests still creates a degree of uncertainty that needs to pass before the euro can engage in a serious rally.
In the meantime, watch for our FOMC Preview this afternoon which will outline the possible risks to the U.S. dollar.