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JPY on the defensive after the quietest weekend in recent memory

Mon, Oct 20 2008, 07:42 GMT
by John Hardy

Saxo Bank

Bank of Canada, Riksbank and RBNZ may all be set to cut rates this week - RBNZ may cut 100 basis points on Thursday.

LATEST HEADLINES

• UK Oct. Rightmove House Prices fall -4.9% YoY vs. -3.3% in Sep.

• Australia Q3 Producer Price Index rose 5.6% YoY vs. 4.8% expected

• China Sep. Producer Price Index rose 9.1% vs. 9.7% expected

• China Sep. Industrial Production rose 11.4% vs. 13.4% expected

• China Q3 GDP rose 9.0% YoY vs. 9.7% expected

• Germany Sep. Producer Prices rose +0.3% vs. -0.4% expected

THEMES TO WATCH – UPCOMING SESSION

Key Risk Events (All times in GMT)

• Canada Aug. International Securities Transactions (1230)

• US Sep. Leading Indicators (1400)

• US Fed's Bernanke to testify to House committee on economy (1400)

• US Fed's Lockhart to speak (1645)

• US Fed's Kroszner to speak (1645)

• New Zealand Q3 Consumer Prices (2145)

• Australia RBA October Minutes (0030)

• Australia RBA's Stevens to Speak (0210)

Market Comments

This has been the quietest weekend in recent memory, with no new major policy initiative from officialdom needed to prop up the failing institution or systemic crisis du jour. The US equity market close looked rather weak on Friday after a buying spree sparked by William Buffett's announcement that he is buying stocks, but the Asian session this Monday opened on a positive note. The standard risk appetite indicators elsewhere are sending mixed signals: interbank lending measures showed a large drop on Friday and the shortest US t-bills showed a rise in yields, but credits spreads on companies were still stretching wider on Friday, and worries over corporate defaults remain very high. In currencies, the JPY was weaker overnight, AUD was stronger and the USD has hardly done anything since Wednesday of last week. Some of the panic pricing in EM - though still within recent "ranges".

An article in Bloomberg this morning points out that corporate default worries may be too high and that a buyer of a diversified basket of high risk corporate debt would need for almost all companies to go bankrupt to not get their money back on the investment (if historical recovery rates on default are still the case). So clearly, a lot of worry has been priced into this market, and yet few are willing to call a bottom as liquidation pressures from hedge funds and possible mutual funds looking to raise cash for redemptions may offset any investors who have enough funds to take advantage of perceived bargain prices. The biggest owners of cash - Middle Eastern and Asian sovereign wealth funds - are showing increasing signs of activity after a long period of quiet and their liquidity will be much needed. Investment flows could have important FX implications: On the reserve diversification side, central banks are likely to be less active as long as the times look so uncertain and their lack of activity may be contributing to the general liquidity problems. This keeps pressure off the weak USD side of the equation. As well, the sudden glaring weaknesses in the European banking sector, which has shown itself to possibly be even more leveraged and worse off than the remaining American banks are known to be, has also likely given central banks pause on pouring their money into Euros. The other pressure that has eased in the reserve diversification universe is the enormous drop in oil prices - with Middle Eastern OPEC powers, for example, now raking in petro-profits at half the rate they were a mere three months ago. This leaves far fewer funds with which to import European goods. All of these affects are USD positive and EUR negative as long as they last. OPEC is set to meet this Friday (a meeting moved forward from November) and is likely to cut production.

Further USD positive potential comes from US portfolio flows. US investors were massive buyers of EM and other international assets during the boom times as they shunned their own stocks and government debt and sent their money where growth rates were highest. With the fall in equities, Americans have already started bringing their money home and are likely to continue doing so as already steep losses mounted further over the last few weeks and EM currency losses adding to the negative calculus. To take a basic example, investors in the iShares Brazil ETF, for example, have seen its value collapse by two-thirds from its May highs this year due to the combined effect of the falling share prices in Brazil and up to a 50% weakening in the country's currency. That ETF is now back to its Oct, 2005 price level.

We wrote last week about the risk of US confidence "double dipping" and this indeed seems to be the case as the US Michigan Confidence number was far worse than expected - at 57.6 vs. 65.0 expected and close to the June low, which was the lowest since the late 1970's. The consumer is receiving a real shock as credit lines dry up and a psychological shock from the events unfolding. It can only mean one thing: a change of behavior and far less enthusiastic use of credit - both because of a new perceived need to secure against uncertainty, and because the credit just isn't there any more. This guarantees a steep recession at minimum.

The week ahead looks quiet on the economic calendar. Three of the G-10 currency central banks are scheduled to meet on rates this week. The Bank of Canada will likely cut 50 basis points to bring its rate to 2.00% - matching the lowest levels from the 2001-3 rate easing cycle. The RBNZ is looking to cut up to 100 basis points (to bring rate to 6.50%) on Thursday and the Riksbank may cut 25 bps on Thursday. There is still plenty more easing to come from the major central banks outside the US/Canada. German 3-month t-bills, for example, ended last week trading around 1.75% - a whopping 200 basis points below the current ECB rate. The ECB is likely going to need to cut deep and cut fast and this could continue to weigh on the EUR in coming months.

Other data this week of note includes the preliminary PMIs from Europe for October, out on Friday, and Retail Sales data from Canada on Wednesday and the UK on Thursday. Momentum seems to quickly be leaking out of the moves in currencies late last week - is this a sign that we will see a consolidation of recent moves (would require equities to continue to find support and rally) or a renewal of the pressures on the JPY, CHF and USD to strengthen (would be triggered by new slide in equities and especially if a new round of systemic risks comes to light.)

Chart: EURUSD

All has gone eerily quiet on the EURUSD chart as traders ponder its next move. A line of resistance seems to have developed around 1.3500/20, but we also have the implications of the small descending trend line drawn on the chart below. The important zone of support comes in at 1.3350-00. The bigger picture suggests that 1.3885 is a very important resistance level (old low and close to major trendline stretching back to 2002).

Published on  Mon, Oct 20 2008, 07:49 GMT