Currencies switched directions yet again yesterday on crumbling equities

Currencies switched directions yet again yesterday on crumbling equities. Risk aversion is back on the agenda ahead of US Payrolls.

The huge surge in risk appetite post-FOMC was roundly rejected yesterday. Will the carry trades continue to take a big hit?

MAJOR HEADLINES – PREVIOUS SESSION

Overnight developments:

• US Fed injected $41B of liquidity into the banking system yesterday, the most since the 9/11 terror attacks.

• US Financial services indices saw lowest close yesterday since last summer

THEMES TO WATCH – UPCOMING SESSION

Key event risks today (all times GMT):

• Norway PMI (0800)

• EuroZone and EZ member Manufacturing PMIs (beginning 0845)

• Canada Unemployment Rate and Net Change in Employment (1100)

• US Nonfarm Payrolls, Unemployment Rate and related data (1230)

• US Factory Orders (1400)

Market Comments

Yesterday's developments showed that late Wednesday's strong reaction to the FOMC meeting - in which the carry trades rallied and equities and interest rates rose sharply - was a whole lot of nothing, apparently. We got tricked into trying to find some significance of what unfolded after the Fed rate cut, but the market quickly taught us a lesson as these moves proved a brief mirage. Still, strong price rejections often serve up enticing trading signals.

The equity rally turned into an equity rout, with the S&P500 off more than 3% from post-FOMC announcement highs and a long rates plunging even more than they had risen on the previous day. These moves resulted in a predictable sell-off for the carry trade in the FX world - with the likes of AUD and NZD being hit the hardest and JPY and CHF rallying sharply. The USD picture was more mixed.

The key trigger for these developments was the US Fed's injection of 41B USD in liquidity - the largest amount injected since the 9/11 terror attacks. This huge demand for liquidity was a strong indicator that banks are still reluctant to lend money and suggest that credit conditions are still a big worry. All of the usual risk indicators rose sharply yesterday. Also, the largest US bank, Citigroup, fell 7% on an analyst's downgrade.

Today, we look to the US employment data to shed more light on whether the market will begin to focus more on the data for the USD picture. We highlighted that economic data matters again after the Fed's shift into neutral, though yesterday's events showed how the FX market as an asset class (rather than the USD view specifically) is still very dependent on the entire risk appetite picture. Below we highlight three charts (EURCHF, USDCAD and NZDJPY) that may all represent the same trade, even though they involve 6 different currencies. Today may be especially interesting for USDCAD with both countries' employment reports on tap.

Conflicting input for the US employment release today: the recent ADP number showed a stronger than expected reading, but this number hasn't done the best job of predicting the Nonfarm Payrolls number. Considering the relatively elevated weekly initial jobless claims numbers of the last several weeks, we consider the odds of a disappointing number compared to the 85k expected for Nonfarm payrolls as a bit greater. Looking at the actual unemployment rate, it is clear that the US unemployment rate has troughed for now after touching 4.4% twice over the last 12 months. Last month's 4.7% reading was a new 12-month high, and anything above today's 4.7% expectations could steal the headlines.

How will the market react if US data is negative today? Would we see a USD rally on this as the market heads for risk aversion mode (fear of lower economic growth) and we discover that the USD is still part and parcel of the risk appetite theme or would we see the market "celebrating" increased odds of a rate cut, higher risk appetite, and a USD sell-off? Judging from yesterday's moves, the short term winds seem to be blowing in favor of risk aversion and there are plenty of non-USD trades to consider, like short cross/JPY and cross/CHF if the equity sell-off deepens.

Charts: EURCHF, USDCAD and NZDJPY

EURCHF - the classic risk appetite trade. CHF moved stronger in yesterday's move toward risk aversion. This is beginning to look like a trend change as we see yet another bearish rejection and a break of the rising trendline. More downside to come toward the 55-day SMA at 1.6567? A move back above 1.6750 again would cloud the outlook once again here.

USDCAD - the falling knife. This pair has fallen in a very persistent and regular fashion for two months. All good trends must come to an end at some point - but picking tops and bottoms is usually a losing proposition. Still, today's combined USD and CAD employment releases and the move toward risk aversion (theoretically favoring a weaker CAD unit) make it tempting to consider a cheap options play for USDCAD upside or at least for protection for trend followers. 0.9520 area is the first resistance.

NZDJPY: One of the highest volatility risk aversion plays is a short position in NZDJPY. We have a classic pattern bearish reversal yesterday - will this trade see follow through lower today? Ask the equity markets!

Note: the support/resistance levels used in the matrix’s of this document are levels derived from yesterday high, low and close. Reference in the text to other support/resistance levels will occur.