For months, we have shared our view in Pro Traders Club to short EURUSD on rallies above 1.4000. When we take longer term positions, profit is often taken on a percentage of the position should price move swiftly in our favour. This opens the possibility of lowering/raising our average entry level as equity is locked into the position. Furthermore, the approach reduces the risk should price move in our disfavour. We are also in a position long USD/CAD spot ref 1.0170, a classic example of using early price spikes to withdrawal equity and re-enter same position size at lower levels should the market open the door.

European government bond yields have not reached alarming levels, though it is clear that the currency union is still very far from finding a structural solution. Germany and France still cannot agree on the functions of the EFSF and it appears momentum is gathering for yet another round of talks aimed at a 'comprehensive solution'. Recent US data was headline inflation has fallen to 3.5%, more than expected while core inflation was steady; capital flows into the US surprised to the upside and industrial production (+0.7%m/m) also registered a positive surprise.

Although these points are still not enough to turn the US into a growth currency, the sustained flow of capital into the US to capture stronger growth will surely pick up speed if such numbers can be maintained and yield spreads move in favour of USD. The Bank of England released its quarterly inflation report, downgrading both its GDP and CPI outlooks. The report stated that inflation is likely to be below target in the next two years and the outlook for growth is unusually uncertain. Growth is expected to be markedly weaker than the Bank had previously thought. This divergence will see selling of GBPUSD. Although we acknowledge that short positions are heavy, event-based short covering over the past two weeks has re-opened the path for fresh downside. Mario Monti was formally sworn in as Italian prime minister with a technocratic cabinet, and we believe he will need to race against time to come up with comprehensive plans to turn around Italy's debt situation, although unlikely. I don't believe you can, in real terms (non intervention) turn around a problem with a new cabinet, in 2 weeks, which has taken 10 years to create. Let's give our heads a shake, shall we? Although all is, for the interim, doom and gloom for Eurozone, this does not mean the EURUSD could not, or would not, rally to 1.4800. We are not married to our positions.

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Spreads in the Eurozone periphery tightened versus Germany, although these moves were largely consolidating the large moves seen over the past two days. The euro followed price action in the fixed income markets, stabilizing after two heavy days.

France appears to be maintaining its position that the EFSF should be given a banking license. In comments made on Nov 16, he said this would be the best way to create a structural firewall around the Eurozone and to prevent contagion. However, French Finance Minister Baroin said that "Germany has reservations that are more than historical, almost sociological and structural, concerning such an intervention from the central bank". Indeed, Germany's deputy finance minister flatly ruled out such an approach, saying "it is essential that the EFSF cannot tap the ECB". Common among politically tied entities, a reinterpretation of the "laws" is not unlikely. Do you recall playing a game with a family member or friend and they change the rules mid course to give themselves an edge. We used to see a lot of this while bobsledding. As our non European nation began to move up the world ranks of a European dominated sport, the efforts made to give themselves an advantage on their own turf became increasingly apparent. It's called human behavior and common symptoms are seen in the masses. Our job as traders is to take a view of how we believe the market will perceive, and respond to, forthcoming events. We are not making "predictions." We are traders who view our parameters objectively and remain open to the constant changes in the market. We are working with human behavior. As a side not, we went on to win the Overall World Cup, the first Non-European nation to do so, and managed to change the traditional ways of the sport.

In a report, Fitch ratings agency said the outlook for US banks could materially worsen if conditions in the Eurozone were to deteriorate. However, the agency acknowledged that US banks had significantly reduced exposure to Eurozone banks.

Italian PM Monti was officially sworn in on Nov 16, Eurogoup chief Juncker said he was the 'right man' to reform Italy. However, Juncker expressed some displeasure at Germany, in saying that Germany's debt to GDP ratio was actually larger than Spain's, but "no one wants to know about that".

The Troika review for Portugal was largely positive. The ECB said the mission agreed on program policies and growth in 2011 was better than expected. However, 2012 would be more challenging in growth terms, and warned that the program's success depended on structural reforms. Crucially, the next EUR8bn tranche would be disbursed either in December or January.

The IMF's Europe director resigned without giving details on Wednesdays.

The BoE released its quarterly inflation report, downgrading both its GDP and CPI outlooks. The report stated that inflation is likely to be below target in the next two years and the outlook for growth is unusually uncertain. Growth is expected to be markedly weaker than the Bank had previously thought. They see the Eurozone crisis as the biggest single risk to the UK. The fan charts show CPI at around 1.3% in 2 years. Provided that CPI begins to decline as the BoE expects, the scope for further asset purchases is relatively high, especially if conditions in the Eurozone deteriorate further.

The BoJ left policy entirely unchanged at Wednesday's policy meeting, as widely expected.

Finance Minister Azumi said his position is unchanged on FX intervention, and we expect the MoF/BoJ to be on high alert in light of recent volatility.

The Securities Markets Program (SMP) Brain Child...

The ECB's increased purchases of Italian and Spanish paper via the Securities Markets Program (SMP) have raised questions about the limits it might face. The answer is simple: we believe there are no legal or technical limits on the programme and its sterilization.

Under the SMP, the Eurosystem (the ECB and the 17 national central banks of the EMU) buys sovereign paper in the market and prints money to do so. The central bank books the bond purchased under "Securities held for monetary policy purpose, Euro" on the asset side of its balance sheet. Thus the asset side of its balance sheet expands by the amount of the purchase. The bonds are booked at cost, and are not marked to market as they are in a held-to-maturity portfolio.

The counterpart on the liability side is simple money creation: usually the bank of the central bank involved credits the current account of the seller by the amount of the purchase.

From a legal perspective, central banks in the Eurosystem cannot finance a public deficit, which means they cannot buy debt on the primary market. But there is no legal limit to doing so on the secondary market.

From an accounting perspective, the ECB can expand its balance sheet as much as it wishes. Indeed, the Fed, BoE and SNB are doing the same in implementing quantitative easing - for far more substantial amounts than the current SMP.

The ECB sterilizes its bond purchases by borrowing from the market on a seven-day basis, so there is also no limit to its sterilization.

Problems would arise if banks in distress use the SMP to get cash they cannot obtain in the market, while other banks hoarded cash and refused to lend to the ECB. However, a scenario in which banks are so desperate to keep cash that they refuse to lend it to the ECB for just seven days would constitute a major liquidity trap. And in that case, sterilization for fear of inflation would be the last of the worries.

Source: Chris Lori, UBS, Bloomberg

Tags: Risk