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Weekly Fx Strategy

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The 3 Limits of Risk Appetite

Mon, Jan 12 2009, 13:16 GMT
by Ashraf Laidi

CMC Markets

Global risk aversion takes over as US equities once again fail to exceed the 25-30% rebound mark. This is the third time since the intensification of the crisis last autumn that the S&P500 and DIA fail to extend their bear market rallies above and beyond 25% that all temporary bounces remain short-lived money-making making opportunities for traders than long-term openings for investors. The 7.2% unemployment rate and half a million job losses underline the deepening dislocation for consumer demand and corporate margins, while a budget deficit above 8% of GDP illustrate the long-term threats for the US currency.

We reiterate that 950 in the S&P500, 92.20 in USDJPY and 35 in the VIX each continue to pose major obstacles for any marked improvement in risk appetite. The upper chart of the two below highlight the ensuing consolidation in the S&P500 between the 950 and 830 levels and the failed attempts to garner more than 25% gains from the lows. The bottom chart shows the Volatility Index (a measure of risk aversion -- inversely related to equities) remains well supported at the 35, which is both the 200-day MA and 50-week MA, each key technical trend measures. The 35 level is also a former resistance level, now acting as a key support.

The trifecta of intermarket obstacles to risk appetite is completed by USDJPY. As we mentioned in our post-payrolls strategy, USDJPY predictably failed to regain 92.20-25 , which is the right shoulder of the ensuing Head & Shoulder pattern on the 4-hr chart. The level also presents the 38% retracement of the drop from the 94.58 high.

Euro faces the question of whether the ECB will cut by 50 or 75 bps in Thursday’s council meeting. Recall Eurozone flash CPI plunged to a 22-month low of 1.6% y/y in December from 2.1% in November, falling well below consensus of 1.8%. Combining the continuously weak inflation figures with the records low in services and manufacturing sector surveys, the ECB is likely to mull the possibility of another 75-bp rate cut to 1.75%. This would lower the EU-UK rate differential down to 0.25% from the prior 0.50%, during which EURGBP charted the course towards parity. Considering that excessive euro strength is the last thing the ECB needs in a recession, it would wish to temper renewed bouts of EUR strength (GBP and USD weakness) via interest rates. This makes the probability of a 75-bp cut as much as 55%, with 45% chance for a 50% rate cut.

Euro’s breach below $1.33 is seen adequately underpinned by $1.3250, which is the 50-day MA and the 61.8% retracement of the rise from Oct low to the Dec high.

Published on  Mon, Jan 12 2009, 13:24 GMT