he USD is strong and the JPY is weak – this is unusual. What gives? Also, EU is pulled between positive economic data and new signs of trouble as things are rotten in the state of Portugal.

The latest EU news
The latest EU news has the focus shifting a bit to Italy on the protests over the new Monti reform package (see more from Steen’s post from earlier today) that was approved by Monti’s cabinet on Friday, but will now has 60 days for the parliament to mull. Mr. Berlusconi, rather than consoling himself after his fairly disgraceful resignation with a fresh string of bunga bunga parties, is making signs that he would like to throw his hat back into the political ring.

Meanwhile, exactly in line with the order that the Euro Zone peripheral countries originally got into hot sovereign debt water way back in late 2009 and early 2010, we suddenly realize today that Portugal’s CDS prices have arched to a new high in recent days. A WSJ article discusses speculation that Portugal will need a second bailout. Bailout fatigue, anyone? How much more can the EuroZone take of this before calling for a more comprehensive approach rather than this “Greece only” PSI and fiscal compact distraction while sweeping all of the rest of the sovereign debt/banking troubles under the ECB’s LTRO rug?

As for the Greece PSI question, nothing is solved yet and it is very clear that the EU finance ministers who are telling Greece to get their house in order are very displeased with the progress thus far on implementing reform measures. Also, the S&P ratings agency’s Chambers said that any Greek deal would likely be classified a default.

The news wasn’t all bad out of Europe today, as the preliminary Euro Zone PMI’s came out better than expected, suggesting even a slightly expanding Germany manufacturing sector and an expanding services sector across the Euro Zone as a whole. But alas, a EURUSD push higher did not hold, and the reversal back lower today was short term bearish (so far) as the psychologically significant 1.3000 has so far not held – though let’s see where the pair closes on the day. EURGBP made a neat reversal as well after making a head-fake through the 0.8380 resistance and the bears have a technical toe hold now to argue for at least a retest of the lows.

What’s up with USDJPY?
In case you haven’t noticed, USDJPY hasn’t been going much of anywhere for a long time - trading between the 76.30 and 78.30 since about November 1. We noted recently that the sudden reversal in bond yields higher over the last few days should be aiding a JPY cross rally (AUDJPY higher, etc., and EURJPY higher as this was happening in an environment of a Euro short covering spree), and this was indeed the case, though USDJPY saw little movement. That latter fact makes some sense given that both US and Japanese rates are effectively nil and the argument can be made for using either of the currencies for a funding currency for carry trades. That and perhaps the unwillingness of the market to test the Japanese MoF/BoJ’s resolve in light of the massive artillery they are clearly willing to apply at any given moment should the level drift too low.

A look at USD and JPY strength over the last 200-trading days shows that these two currencies have a positive correlation of +0.87 versus the remainder of the G10 currencies. That’s due to the recent lack of USDJPY volatility, you say? If we take the two back to the previous 200-days, the correlation is still +0.68. In other words, today’s move is relatively unusual.

So why did today’s move happen? It certainly doesn’t appear to be anything the BoJ said overnight, as the BoJ merely took the opportunity at its meeting to forecast that a recovery would come later than expected (after the end of the financial year on March 31 and made no change to its asset purchase program. There was no official word that intervention had taken place today. Perhaps the move is from a spreading belief that the US recover is for real, that the Euro pessimism is overdone and that the Japan will be the quickest to get into trouble if rates rise further.

Chart: USDJPY
USDJPY leaped to attention after the action stayed muted despite a much weaker JPY in the crosses in previous days. Today the JPY was weak against most other currencies. In USDJPY, the move took the pair back through the Ichimoku daily cloud. If this move is going to develop into something for the first time in many months, the next resistance levels that must be taken out are the 78.25/30 range high and the falling 200-day moving average, currently around 78.40.

Looking ahead
Tomorrow is FOMC day, and today’s retrenchment in pro-risk trades (AUDUSD, etc..) could be a mere bout of consolidation in recognition that it is often a significant event risk after markets have made a rather significant run higher in recent days. Expectations for the meeting aren’t particularly intense – though we able to perform the novel exercise of sifting through individual (if anonymous) forecasts for when each of the FOMC voting members expects the Fed will eventually move to raise rates. It would certainly be more interesting to get their off the cuff comments on whether they expected to have to do QE again and if so, what kind and how much.

Watch out for the Australian Q4 consumer price data tonight as well as Obama’s State of the Union address (the contents of which have been widely telegraphed and are unlikely to have significant near term market impact). Tomorrow we have the German IFO survey, UK Q4 GDP and the latest BoE minutes.

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