China-Japan FX Pact Rouses Quiet Market

FX markets was quiet on either side of Christmas but a surprise currency deal between China and Japan made waves. AUD was the best performer on Dec 26 but overall moves have been miniscule. The minutes of the Nov 30 BOJ meeting showed growing concern about Europe. Premium trades due next. Latest CFTC Committment data are below.

China and Japan, the second and third largest economies, agreed to promote direct currency exchange rather than settling trades in USD. The move is designed to promote trade and cut costs. Japanese companies will also be permitted to issue debt in yuan in a move that could help to weaken JPY over time.

More specifically, Japan will make an initial purchase of 500 million dollars (about JPY 39 billion) in Chinese government bonds using its foreign currency reserves in the Foreign Exchange Funds Special Account. We saw last year how China has already began increasingly investing in Japanese stocks & bonds, reaching JPY 10.5 trillion by end of 2010.

On the other hand, China strictly regulates outside investment, and allows only a limited number of foreign governments and central banks to purchase Chinese government bonds. Australia, Malaysia and Singapore are among this select group.

The main takeaway is that two old rivals have started to co-operate economically and that is a positive for global growth. Meanwhile, the dollar continues to slowly lose its status as the lone reserve currency.

Asia-Pacific trading has been choppy after a quiet Boxing Day. Flows appear to be dominating in an extremely thin market. Gold is a main loser, falling to $1597 from $1606. Overnight, Japanese Nov housing starts fell 0.3% y/y following a 5.8% decline in Oct.

The Bank of Japan released the minutes of the mid and late November meetings. Growing concern about Europe was a theme with all members saying market stress was likely to persist for a protracted period. They said the risks point to a higher yen, which could hurt the economy.

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Commitments of Traders

Fridays CFTC report on non-commercial positions showed a reversal in some recent trades anticipating risk aversion. Although commercial open interest declined dramatically, traders were adding to EUR positions; pointing to the possibility of volatility at year end. The net euro position fell from a record -116K to -114K.

The net JPY position fell to +24K from +35K. The sterling net improved to -26K from -34K. The Canadian dollar was unwanted, falling to -27K from -16K. AUD fell to +26K from +33K.

US markets await the Oct Case-Shiller house price index at 9 EST, followed by Dec consumer confidence at 10 EST.