China hikes rates

It’s not the first time when China makes some key decision on Saturday in order to minimize market impact and this time it additionally took advantage of Christmas time to increase interest rates for the second time this year. So far it succeed in making it smooth – an initial reaction after opening on Monday was moderate and was quite quickly reversed.

At the first glance, it might seem the market is resilient to the bad news from China – it shrugged inflation (when it did exceed 5%), it didn’t collapse after worrying news about curbing car sales and now it doesn’t react to the hike. Moreover, one can even hear comments that it is actually positive (!), as it eliminate risk and uncertainty. So far so good – Chinese authorities still seem to be far behind the curve when it comes to monetary tightening and it will be interesting to see for how long investors can remain so sanguine.

EURUSD – euro gains, faces 1,32

If the hike in China - a clearly euro-negative news – didn’t push the EURUSD lower, the Holiday week may look promising for the euro bulls. The euro advanced vs the dollar and Swiss franc and the EURUSD broke away from the declining channel (encompassing the pair last week), rising to 1,3170. Further gains are limited by a resistance zone of 1,3180-1,32 but if it can be conquered, the pair may try to go for a mini yearend rally with the key resistance at 1,35.

That said, medium term picture for the euro remains bleak. With a help from rating agencies, credit spreads remain elevated. With base yield (on German bunds) somewhat higher, Spanish 10y is still trading close to the record yield of around 5,5%. That means the risks for the euro are still there and Holiday period may make them overlooked but not reduced.

Events to watch – Japanese package

Last week of 2010 is very light – most of the key data was already released and actually only the US Conference Board released on Tuesday carries some relevant weight. Monday’s calendar is actually empty and markets in UK and Canada – closed. Tuesday’s Asian session will bring about the Japanese package. In theory, data on output, sales, inflation and unemployment should attract a lot of market attention but in reality, the domestic data rarely has a visible market impact, even on the USDJPY. One should keep in mind though that this light week is preceding a very intensive start of the 2011. The first week of the New Year will be stuffed with US payrolls, activity data in US and China, BoJ meeting, Fed’s minutes and more.

Przemysław Kwiecień PhD, Chief Economist

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