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Bottom falls out of EURJPY

Mon, Oct 6 2008, 11:11 GMT
by John Hardy

Saxo Bank

Market action looks dire. USD and JPY continue to power strong as TARP bailout package failed to ignite rally in risk appetite.

THEMES TO WATCH – UPCOMING SESSION

Key Risk Events (All times in GMT)

• Canada Aug. Building Permits (1230)

• Canada Sep. Ivey PMI (1400)

• US Fed's Evans to Speak (1600)

• New Zealand Q3 Business Opinion Survey (2100)

• Australia Sep. AiG Performance of Construction Index (2230)

• UK Sep. NIESR GDP Estimate (2301)

• Japan BoJ Target Rate (no time given)

• Australia RBA Cash Target (0330)

• Japan Aug. Leading Index (0500)

Market Comments

The JPY continues to reign supreme as we usher in a fresh week of credit crisis mayhem that just never seems to let up. EUR crosses - especially EURJPY - have fallen out of bed to start the week as the credit crisis shockwaves continue to roll with full force over Europe on Friday and through the weekend. The market is nervous about Europe's ability to deal with the crisis due to the difficulty in coordinating policy. A summit of the major EU powers over the weekend even ended in an announcement that coordinated action was NOT to be taken! Germany's Merkel ominously said: "Each country must take its responsibilities at a national level" The market didn't like this and EUR was punished from the get-go in Monday's Asian session.

Signs of lack of policy coordination were already evident last week, with Ireland's move to insure deposits earlier last week followed up on Friday in Greece with an identical move. Then over the weekend, Germany also moved to insure deposits. It appears likely that the rest of EuroZone countries and even the UK will now also be forced to move in this direction to stem any arbitrage potential.

In addition to the lack of coordination, two main stories have shown European policy-makers' difficult time with initial stabilization efforts: first, the Fortis bank rescue, in which Fortis has now been thrown into the arms of BNP Paribas after a clumsy rescue effort last week failed to rein in that bank's problems. Secondly, the initial efforts to bail out the very large German Hypo Real Estate bank failed and a new and even larger package was required over the weekend to prop up that entity - EUR 50 billion for just one bank!

The scariest aspect of these stories is less the stories themselves, and more the question of unknown contagion as the credit crisis rolls on. These are just two banks - and there are many more and many larger banks out there in Europe and the question is who is next? European banks have been even more leveraged than their US counterparts during the credit boom... As long as this story burns, it appears that the EUR is headed lower until we see a general rebound in risk appetite or a more decisive and coordinated response from European officialdom (something this weekend's summit virtually guaranteed against). The next technical area of interest is just below 1.3400 in EURUSD (the 200-week moving average) and EURJPY has taken out every technical level down to 140.00 and shows no signs of letting up.

Friday's crazy action in the US was a story unto itself: Previous to the bail-out package passing muster in the House of Representatives with a solid majority, bond yields and stocks were sharply higher on the day - but then the bottom fell out of the market as it made its own vote on the TARP package and new lows traded into the close. Now we're down almost another 2% before the European session even opens. We'll need to watch the spreads for a while in the US to see if the package is having any effect. The credit crisis is widening in the US now, with the spotlight now shifting to mainstream corporates that are desperately in need of refinancing, but also state and local government finances - with countless entities in dire straits

In the UK, the lead financial story this morning is of a plan drawn up by Chancellor Darling to inject capital into the banking system by buying new shares in the banks to shore up their capital ratios. The GBP has fared very well against the EUR, first because the market was already very pessimistic on the UK relative to EUR until recently and secondly, because at least the UK has the ability to coordinate domestic policy with the BOE and government working in coordination EURGBP broke to a new 6-month low - falling through a well-defined range marker just below 0.7800 and could be heading lower still - possibly to 0.7500 eventually.

In light of the fast-paced action and non-stop stream of ad hoc stories hitting the wires, the economic data has faded into the background and some of it looks a bit bizarre. The ISM Non-manufacturing reading of 50.5 for September out on Friday, for example, makes absolutely no sense and must be behind the curve.

Watch out for the RBA out tonight and likely to chop 50 basis points off the cash target to bring the rate to 6.50%

Be very, very careful out there - these markets are very dangerous.

Chart: EURJPY

This is the ultimate expression of the state of play at the moment. EURJPY closed higher 8 years in a row. This year will break the streak - but how many years of appreciation can we erase between now and the New Year? The pair has fallen through all support save for this psychological 140.00 area (was also an old resistance area back in the day....) and there are no signs of stabilization just yet....

Published on  Mon, Oct 6 2008, 11:16 GMT