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No signs of hope yet from credit market

Fri, Oct 3 2008, 06:57 GMT
by John Hardy

Saxo Bank

Key test for market sentiment today with TARP vote up in the House and after US equities touched recent lows yesterday.

MAJOR HEADLINES

• US Aug. Factory Orders fell -4.0% vs. -3.0% expected

• Australia Sep. AiG Performance of Service Industries rose to 44.9 from 39.3 in Aug.

• Switzerland Sep. CPI out at +0.1% vs. -0.1% expected

THEMES TO WATCH – UPCOMING SESSION

Key Risk Events (All times in GMT)

• Norway Sep. PMI (0700)

• Germany Final Sep. Services PMI (0755)

• EuroZone Final Sep. Services PMI (0800)

• UK Sep. Services PMI (0830)

• EuroZone Aug. Retail Sales (0900)

• US Sep. Change in Nonfarm Payrolls (1230)

• US Sep. Unemployment Rate (1230)

• US Sep. ISM Non-manufacturing (1400)

Market Comments

EURUSD plummeted to a new 12-month low yesterday as Trichet brought absolutely nothing new to the table and essentially highlighted what everyone is already worrying about: that Europe is incapable of the kind of unified US response to a systemic banking crisis. The clear message after the expected "no change" decision on rates at Trichet's press conference was that the ECB is looking to ease rates at the next meeting. We think they will have eased at least 50 basis points by the end of the year. Mr. Trichet changed his language on perceived inflation risks and had a more dour view on growth in line with what is now painfully obvious in the rear-view mirror for the EuroZone economy. In the background, IG Metall is looking for an 8% pay increase just as Germany is performing a spectacular crash landing...it will be interesting to see what kind of agreement emerges for these workers on the other side of negotiations.

It was almost humorous to see the plunge in EURUSD accelerating most when it crossed the wires that a "rate cut had been discussed". Shock! Awe! Really, folks - if Trichet and company hadn't at least discussed a rate cut, then you would have to wonder if they lived on the same planet as the rest of us. While EURUSD did post new lows on the day, the action later in the day quieted and overnight EURUSD was even rallying up toward the first key resistance area at 1.3885, the old low and the approximate spot where the huge rising trendline from 2002 was broken.

The market fear level remains very high as evidenced by the various credit spreads and other indicators that simply aren't coming down yet. It's rather scary to be headed to another weekend of uncertainty with the TARP vote today (we assume it will be passed - big question is of course the reaction) and a probably very ugly US employment report. Unfortunately, the US employment indicator is a terribly lagging one - with the accelerating weakness already in the pipeline, we fear US unemployment could reach toward 8% next year - which would be the worst since the early 1980's, when the US was still emerging from stagflation. Research report after research report discusses the self-reinforcing aspects of the enormous web of credit dependencies in this situation, including everything from consumer financing to especially local government funding. The basic message is that the latest tightness will cause cutbacks, cutbacks, cutbacks. And every day that credit markets remain so dysfunctional, the belt tightens another notch.

The FX market will likely move along the axis of fear as it has consistently been doing lately. More fear and credit tightness likely equates to a stronger USD and JPY and any dramatic easing in fear levels means that we should all buy EURJPY. Those looking for a lottery ticket might look for a Monday expiry low-delta EURJPY or AUDJPY call if fear spikes even higher after the US employment report...more as an expression of hope that things won't simply continue to get worse in an unmitigated straight line than anything else....we find little reason to hope for positive outcomes here in the short term - but sometimes it's best to fade the fear. Of course, you can also embrace the fear with Monday low-delta EURJPY/AUDJPY puts on any rallies in risk appetite this morning. The spot market should be played with low leverage. Our basic ATR indicator shows that EURUSD is more than 3 x more volatile than it was in July of last year just before the Bear Stearns funds blowup kicked this whole credit crisis in motion.

As always, be careful out there...

Chart: EURGBP

The EUR weakness has become so pronounced that it is now even moving decisively lower versus the British pound, where so much pain had already been priced in. The relative strength in GBP is most likely a result of a deleveraging environment (taking off existing GBP shorts and EUR longs broadly speaking) rather than an expression of confidence in the UK economy, which is a study in slowly unfolding train wrecks. Nonetheless, if the support area just below 0.7800 gives way (this is the flatline support - the 200-day moving average comes in already close to current levels), we wonder if this could open up for a significant test lower toward 0.7600.

Published on  Fri, Oct 3 2008, 07:00 GMT