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AUDJPY dropped as much as 13% yesterday − was that the capitulation?

Tue, Oct 7 2008, 07:47 GMT
by John Hardy

Saxo Bank

100-bp cut from RBA sees AUD bouncing vigorously from yesterday's lows. Risk aversion hopefully has peaked in the short term.

LATEST HEADLINES

• New Zealand Q3 NZIER Business Opinion Survey rose to -19 from -64

• Australia's RBA cut rates 100 bps vs. a 50 bp cut expected

• Australia Sep. AiG Performance of Construction Index fell to 31.8 vs. 43.1 in Aug.

• Bank of Japan left target rate unchanged at 0.50% as expected

THEMES TO WATCH – UPCOMING SESSION

Key Risk Events (All times in GMT)

• Norway Aug. Industrial Production (0800)

• UK Aug. Manufacturing Production (0830)

• Germany Aug. Factory Orders (1000)

• US Fed's Stern to Speak (1500)

• US Fed's Bernanke to Speak (1715)

• US Fed's FOMC Minutes of Sep. 16 meeting (1800)

• US Weekly ABC Consumer Confidence (2100)

• UK Sep. Nationwide Consumer Confidence (2301)

• Australia Oct. Westpac Consumer Confidence (2330)

• Australia Aug. Home Loans (0030)

• Japan BoJ Monthly Report (0500)

Market Comments

Surely yesterday was some kind of short-term capitulation across markets: we certainly hope so, as AUDJPY was down as much as 13%+ on the day before the big bounce overnight. The RBA cut a surprise 100 bps - which really shouldn't be surprising considering the market action of late and shows more foresight than what we are seeing from the BoE and the ECB. The AUD selling was so overdone that the 100 bp cut may actually be seen as a good sign that the RBA is at least willing to do something to shore up the economy relative to other central banks (notably of the European variety), interest rate differentials aside.

Despite shifting into outright panic mode yesterday that lasted well into the North American session, signs of hope materialized into the close in the US and continued a bit overnight, with very robust bounces in equity indices (S&P500 is up some 6% from its lows of yesterday as this is being written) A chunky bounce, to the say the least, also arrived in JPY crosses - which would of course look more impressive were it not for yesterday's cliff-diving act.

The credit crunch grinds on, but the next step by the Fed is beginning to crystallize: the need to extend credit directly to institutions that desperately need to roll over their debt and can't get funding from banks, where all lending has essentially stopped. This is a lead story almost across the board and must be followed closely - as this step will be needed to prevent a total meltdown and immediate real economy effects (the longer term economic effects of all this have already been set into motion) In other words, the Fed's drastic liquidity measures are not spilling over to non-banking institutions and now they are very likely to address this problem with an unprecedented move into unsecured lending. Watch Bernanke's appearance today for a follow-up on this story. Such a move could prop up the corporate commercial paper market and the state and local government debt markets and finally start to rein in some of the credit spreads that are signalling totally frozen credit of late. If these measures are able to bring credit spreads down in the coming days, we may have room for a further relief rally in risk appetite (with usual implications for JPY and CHF) . The situation for the EUR is less clear, as the policy response has been, and may continue to be, far more difficult due to the unworkable ECB/fractured national framework.

The UK Chancellor Darling is also hatching a plan to invest government funds in banks in exchange for shares in those banks, in a program modelled after a Swedish bank rescue executed in the early 1990's.

There's also talk of a coordinated global rate cut arriving as soon as this weekend's G-7 meeting after the RBA cut 100 bps overnight. Certainly, this is a sentiment booster if it happens, and is particularly necessary in the UK and in the EuroZone. But credit markets remain the key....

Chart: AUDJPY

We've removed 6 years of the carry trade in the space of two months with yesterday's move in AUDJPY, which we expect may be a short term climax of sorts, if not on an absolute level basis, at least on a volatility basis. The market in AUD got downright disorderly and we smelled panic driving the action rather than rational moves when we look at crosses like AUDNZD, which has come completely unglued as well. If you want to go bargain hunting in AUD-cross land, AUDNZD might be a less dangerous place to start for a bounce...and EURAUD is looking expensive soon as well...

Published on  Tue, Oct 7 2008, 07:50 GMT