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JPY and CHF longs head for the exits...

Tue, Oct 14 2008, 08:07 GMT
by John Hardy

Saxo Bank

How much further can we bounce? AUD and GBP making impressive gains across the board.

LATEST HEADLINES

• US plan emerges to inject $250 billion of capital into major banks in exchange for shares

• EU governments pledge as much as EUR 1.9 Trillion to insure interbank lending and inject capital into banks

• UK BRC Sep. Retail Sales Monitor showed same store sales down -1.5% YoY

• UK Sep. RICS House Price Balance out at -84% vs. -85% expected

• Japan Sep. Domestic CGPI fell -0.4% MoM vs. -0.6% expected

• Australia Sep. NAB Business Confidence fell to -8 from -7.

• Japan Sep. Consumer Confidence rose to 31.8 from 29.9 in Aug.

THEMES TO WATCH – UPCOMING SESSION

Key Risk Events (All times in GMT)

• UK Sep. CPI/RPI (0830)

• Germany Oct. ZEW Survey (0900)

• EuroZone Aug. Industrial Production (0900)

• US Treasury's Paulson, Fed's Bernanke to speak on bailout program (1230)

• EuroZone ECB's Trichet to speak (1615)

• US Weekly ABC Consumer Confidence (2100)

• Japan Aug. Current Account (2350)

• Australia Aug. Westpac Leading Index (0030)

• US Fed's Bullard to Speak (0030)

Market Comments

Risk appetite was already on the mend yesterday after global officialdom woke up and smelled some very strong coffee over the weekend. While new moves by the US treasury were clearly underway, however, the market wasn't quite sure what form these measures would take until late yesterday, when news emerged that part of the TARP plan will include an injection of capital directly into the banks - $250 billion to begin with, and $125 billion going into the largest nine banks. In exchange for the funds, the banks will issue preferred shares and would be required to limit executive compensation. Other measures intended to reduce counterparty risk include the guarantee of all senior debt issued over the next three years and unlimited FDIC insurance on non-interest bearing accounts (essentially corporate accounts). This approach is widely considered far better than the "toxic asset lifting" approach of the original TARP concept, and the market responded with a strong rally - or should we say bounceback - in risk appetite. An official announcement is theoretically to be made today by the US Treasury at 1230 GMT. The S&P500 has already soared as much as 25% from its Friday low - a historic turnaround after a historic sell-off. In FX, this resulted in the expected sharp sell-off in JPY and CHF and a very sharp rally in AUD and GBP. The USD continues its pattern of tending to the weaker side as risk appetite grows.

The sharpest rallies in equity markets are always to be found in bear markets, in which the rally is usually preceded by a steep sell-off. The potential is certainly there for this rally to extend a bit further, especially as we are likely to see a sharp contraction in the. Further out, it's a bit tough to get overly excited about what is going on here. Undoubtedly, we must celebrate that we have saved the patient's life, but we're not ready to check the patient out of the hospital just yet as that patient may be in for a long detour and recovery over at the sanitarium. For those that don't like that awkward metaphor, what we mean is that the damage is already done in the bigger perspective - because banks will survive and we won't have a systemic meltdown does not mean that we can get right back to inflating a new credit bubble - the old bubble is still unwinding and will be for several quarters to come. The deleveraging at all levels - lastly and most importantly at the consumption level - will continue.

In other bailout news, the EU has pledged as much as EUR 1.9 Trillion (!) for guaranteeing interbank lending and in capital injection schemes aimed at shoring up bank balance sheets. The Australian government announced a 1% of GDP stimulus package, modeled after the US "send everyone a check" plan.

After the breathtaking events of the last four days (Friday to yesterday) the scenario may begin to shift here. We may be able to shift away from this ultra-high alert, scanning of the headlines for the next ad hoc story and its implications for systemic contagion/mayhem/chaos/armageddon. Hopefully, in fact, most of those last four words can begin to exit our vocabulary. Instead, we may be more likely to head back to a less white-knuckle environment where instead of imagining whether the world is going to explode, we analyze how it will slowly im-plode: the longer term process of the bubble unwind and how it will impact the global system and what form the new market paradigm will take. We do stress that this is a transition, however, and that volatility could continue to spike in places, but our best guess is that the volatility cycle has peaked for now.

This also means that we can probably get back to noticing incoming economic data. Imagine that. EuroZone Aug. Industrial Production anyone? This indicator of industrial activity has been trending lower all year and could deepen for the Aug and Sep readings. We're also very curious about these consumer sentiment indicators and their ability to stabilize in recent weeks - our guess is that at the popular level, gasoline prices, when they were accelerating so rapidly for the entire first half of this year, had been a key determinant in people's view of the world. That would explain why we saw a stabilization and even bounce in consumer confidence as gasoline prices fell back sharply, even as the financial markets went to Defcon 1. Consumer activity will be key for the degree of severity of this recession. The weekly US ABC confidence number is out tonight.

For those playing the continued recovery scenario, have a look at buying AUD - perhaps vs. the USD or vs. the EUR. Long AUDJPY is the highest-beta trade in the G7 universe at the moment. Still, it's tough to play a market like this, and traders are worse than nervous after the recent moves in the markets, so any swings in the market are likely to be large and sloppy before we get back to more "normal" trading conditions, so keep leverage very light for now.

Chart: AUDUSD

AUDUSD suffered catastrophic damage during the recent all-out financial panic. In these situations, when relief returns to the market, the most heavily sold become the most heavily bought - and that's what we're seeing here. Where can we rally to? For starters we have an interesting retracement and flatline area at around 0.7150/60 and then higher up we would look at the round number 0.7500 and then the 0.618 Fibo of the last downward leg at 0.7685.

Published on  Tue, Oct 14 2008, 08:11 GMT