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It has been a fairly uneventful open in Europe today as the biggest moves happened in the Asia session after the news of the death of North Korean leader Kin Jung-Il broke. This hurt the yen and the Korean won due to their geographical proximity to North Korea. However, after breaking above 78.00 on the news, USDJPY has nearly given back all gains and remains below 78.00. The South Korean won has remained under pressure, and likewise the Kospi (the South Korean index) is also under pressure.
Although his son Kim Jong-un has been described as his father's successor, transitions in power in a country that holds nuclear weapons and where the military is incredibly powerful rarely happen smoothly, so geopolitical risk has added to uncertainties in the region as we get near to the end of the year.
For investors this has added to risks and fears emanating from elsewhere as we near the end of the year. Not only is 2011 gearing up to be one of the most event-filled years in recent memory, but, interestingly, the majors are likely to end up fairly close to where they started 2011. EURUSD dipped below 1.30 at the end of 2010 post the Irish bailout. A year later and Italy and Spain have been dragged into the fray and the currency is back at the same level. Something doesn't feel right about that - the euro crisis has escalated dramatically in the past year and yet EURUSD hasn't really moved.
While the euro is lower versus the yen, the resilience of EURUSD could be because the US has problems of its own, which limits the amount of demand for the greenback. Although Congress was expected to have passed a new spending bill to extend the payroll tax cut and unemployment insurance this weekend it has run up against some resistance in the House of Representatives. The safe passage of this bill is vital for growth in the first half of this year. Since US growth has been the one stabilising force for risky assets in recent months, the latest bout of political wrangling on Capitol Hill could cause excess volatility before year-end.
Added to this, the Eurozone debt crisis remains centre stage. Eurozone finance ministers are meeting later today at 1430 GMT to discuss plans for an IMF loan from the currency bloc to the tune of EUR200bn. Expect headline risk later today. ECB President Mario Draghi was talking to the FT today and reiterated that the ECB will not make large-scale purchases of government debt. Thus, this loan to the IMF is vital to ensure some financial firepower in the event of a deeper debt crisis in Italy next year when it is due to auction EUR 112bn of debt in the first quarter alone.
Today Eurozone bond yields are slightly lower but well within danger territory especially for Italy, who saw its 10-year bond yields jump above 7% on Friday. They have since moderated to 6.95% today. In contrast French 10-year bond yields are higher although they remain below the 3.7% high from November. There is a real chance that S&P will downgrade France possibly by two notches this week, thus, this threat may not be fully priced into the French bond market just yet. French central bank president Noyer said today that the ECB has fully played its role as lender of last resort, some may disagree with this since bond yields continue to rise in the weakest financial states of the currency bloc. He also said that common fiscal governance is of the essence.
So as we enter the last full trading week of the year risk levels remain elevated. Price action suggests that investors are still fearful of taking long positions in anything remotely risky, which is good news for the dollar and the yen (North Korea pending). We have some micro volatility going on today: European stocks opened lower and are now higher. Likewise, the EURUSD remains smack in the middle of its recent range after failing to break above 1.3050 earlier.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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