USDJPY Hits New Low

Investors remain in wait-and-see mode as EU leaders gather for their second summit in the space of a week in search of a comprehensive solution to the Eurozone debt crisis. With significant divisions between policymakers, expectations are fairly low. Given this negativity in markets, it is surprising that euro has held up relatively well. This suggests that investors who wish to be short the euro are already positioned so, and the holdouts on the sidelines. Things today begin at 1600 GMT, with the entire complement of 27 EU leaders due to attend a short meeting. An official statement is unlikely to arrive until later on.

USDJPY touched new post-1945 lows of 75.71, and the BoJ will be under pressure to announce further measures when its meets tomorrow. Intervention is a significant risk but we believe the Ministry of Finance will wait to see the market's interpretation of today's EU summit before acting. Overnight, EURUSD traded 1.3893-1.3953 and USDJPY 75.72-76.16.

Research Spotlight "Europe's Lost Dollars" UBS G10 FX Strategy

The high cost of dollar funding - a key feature of the recent Eurozone crisis - matters for FX in several ways. It is a crucial barometer of risk appetite, the dollars 'taken away' represent a genuine reduction in supply, making the unit cost of dollars much more expensive, and the shortage entrenches the view that there is no alternative to the greenback. Investors should not assume that the money is going to flow back if/when all is said and done on the sovereign debt front. See "Europe's Lost Dollars" on www.ubs.com.fxweb for further details.
EUR Targets: EURUSD 1m 1.30, 3m 1.20

Three events on Wednesday are likely to vie for investor attention. First, the German parliament is due to vote on whether to authorize the use of EFSF leverage. Our European economists expect the vote to be carried without difficulty, although they acknowledge the "slight risk" that the motion may fail. In the latter (albeit unlikely) case, Chancellor Merkel would have no mandate to approve the use of leverage at the Eurozone summit later that day, and the euro would likely experience a sharp fall.

The first summit is scheduled to begin at 1600 GMT, where the entire complement of 27 EU Leaders are due to attend for a short meeting. A second summit of only the leaders of the 17 Eurozone countries then convenes at 1715 GMT. We expect a formal communiqu? to be released eventually, plus a possible press conference, but no set times have been given. However, given the group clearly has much talking to do, we would not be surprised to see discussions continue until 2200 GMT or beyond.

Newswire headlines suggested that much work remains to be done on the Eurozone's so-called "comprehensive solution". Un-named EU officials said that Wednesday's Eurozone summit communiqu? is unlikely to quantify precisely the EFSF's new leveraged capacity. Instead, a range of possible sizes might be announced. It also appears that a firm figure will not be provided for the size of the EU's bank recapitalization ambitions. We also think we are unlikely to hear a concrete figure for the size of bondholder losses, but it will likely be made clear that the eventual figure will be well in excess of 21%. In short, the summit is likely to be largely a disappointment as far as investors hoping for finality are concerned.

Reuters cited a "senior Eurozone source" as saying that the summit draft conclusions are unlikely to include a phrase on continued ECB non-standard measures. This in line with what German sources said yesterday.

ECB's Draghi said that Italy is being hurt by delay in reforms and exposure to domestic issues. In his ECB capacity, he said that downside risk to growth is 'significant' and is determined to fight the crisis.

Political tensions in Italy continue to build as a package of pension reforms is assembled ahead of Wednesday's EU summits. The EU is insisting on specific measures and commitments and it is not clear if the Italian government is in a position to strike a compromise with the opposition on the matter.

USDJPY Targets: USDJPY 1m 77.00, 3m 75.00

The Bank of Japan's two-day meeting is due to begin on Wednesday, with an announcement expected around 0400GMT on Thursday. The Nikkei newspaper reported that further easing will be discussed, perhaps by expanding its existing JPY 50 trn asset purchase facility by JPY 5 trn. We note that this is one of the gentler easing steps the BoJ could take, and that any ensuing USDJPY upside is likely to be small and short-lived and forgotten about entirely within a few hours.

Japanese Finance Minister Azumi said he had told G20 meeting Japan sees USDJPY level of 76/77 as appropriate, and stressed that he didn't think the G20 communiqu?'s wording on FX prevented Japan from intervening in markets. He also said Japan was ready to buy more EFSF bonds if Europe comes up with a credible solution.

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