EUR/USD
The Euro remained under pressure in European trading test support close to 1.3250 before finding support. There were further very important concerns surrounding the Euro-zone which undermined the currency as internal yield spreads edged wider due to an underlying lack of confidence.
With Eurogroup Finance Ministers meeting on Monday and further discussions due on Tuesday, there was further speculation over internal divisions. There was strong evidence that Germany would oppose any additional funds for the European Stabilisation fund as domestic political opposition to the bailouts remains high. Any serious public divisions would certainly reinforce a lack of confidence in the Euro.
The short-term focus will be on the Irish budget which is due to be presented on Tuesday and failure to pass the legislation would trigger a renewed spasm of fear surrounding the Euro given that the Irish rescue package would also be under threat. Budget agreement would provide near-term relief, but it will be more difficult to secure a sustained improvement in Euro-zone confidence.
The dollar is still suffering to some extent following the weaker than expected employment data and it was unable to take full advantage of the Euro vulnerability. In this environment, the Euro recovered back to the 1.3350 area against the US currency and was able to maintain a slightly firmer tone in Asia on Tuesday.
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Yen
The dollar was unable to regain the 83.20 level against the yen on Monday and came under selling pressure during the US session with a dip to three-week lows below 82.50. Underlying risk appetite remained generally fragile which provided some background yen support, especially with fears surrounding the Euro-zone contagion risk. It remains the case that confidence in the Euro and dollar remains weak which will maintain defensive yen support.
In Asian trading on Tuesday, there was further speculation surrounding a potential Chinese interest rate increase late this week and this maintained a cautious attitude towards risk which underpinned the yen.
The domestic data remained weak with the monthly Tankan manufacturing index retreating to a 7-month low and there will be further pressure for the Japanese authorities to curb further yen appreciation. The dollar did find support on dips to 82.35, but was unable to make significant headway.
Sterling
Sterling found support on dips toward 1.5650 against the US dollar on Monday as movements were dominated by Euro and dollar moves. As the US currency lost support, Sterling recovered back to the 1.5750 area with the Euro hitting resistance close to 0.85.
The latest BRC retail sales index was subdued with a 0.7% increase in the year to November. Underlying confidence in the economy is likely to remain fragile, especially with expectations of a sharp slowdown in early 2011 as tax increases take effect. There will be caution ahead of the Bank of England policy meeting on Thursday, although the most likely outcome is that policy will be held steady at this point.
The UK currency will continue to gain some important near-term protection from a lack of confidence in the Euro-zone and dollar, although volatility across all currencies is liable to remain an important feature.
Swiss franc
The dollar found support below 0.9750 against the franc on Monday and advanced to the 0.9870 area, but the US currency was unable to sustain the gains and retreated back to the 0.98 area. The Euro remained generally on the defensive against the Euro, but there was support close to 1.30.
The Euro-zone developments will inevitably be watched very closely in the short term and there will be further defensive support for the Swiss currency if the Irish budget is rejected on Tuesday.
Domestically, the seasonally-adjusted unemployment rate held steady at 3.6% for November and the main National Bank focus will be on any signs of deflation.
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Australian dollar
The Australian dollar found support on dips towards 0.9850 against the US currency on Monday and strengthened back to the 0.9910 area as the US currency was unable to sustain gains.
As expected, the Reserve Bank of Australia left interest rates on hold at the 4.75% level following the latest monetary-policy meeting and there will be expectations of no change in the short term. This will limit buying support for the currency and there will be unease over another weak reading for the PMI construction index, but there will still be solid yield support.
There was further speculation that China will increase interest rates late this week and this will deter aggressive Australian dollar buying in the near term.
