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RBA cuts more than expected, hits AUD crosses

Tue, Nov 4 2008, 07:43 GMT
by John Hardy

Saxo Bank

Long bonds rally again yesterday, boosting the JPY. US election drama this evening - tough to gauge potential reaction.

MAJOR HEADLINES – PREVIOUS SESSION

• Australia Cash Target lower -75 bps to 5.25% vs. -50 bps expected.

• Switzerland Oct CPI out at 0.5% YoY vs. 0.4% expected

THEMES TO WATCH – UPCOMING SESSION

Events Today:

• Norway Oct. PMI (0800)

• UK Oct. Construction PMI (0930)

• EuroZone Sep. PPI (1000)

• US Sep. Factory Orders (1500)

• US Weekly ABC Consumer Confidence (2200)

• Australia Oct. AiG Performance of Service Industry (2230)

• UK Oct. Nationwide Consumer Confidence (0001)

• Australia Sep. Trade Balance (0030)

• Australia Sep. Building Approvals (0030)

Market Comment:

Australia surprised with a 75 bp cut to the cash target - bringing the rate to 5.25%. No one surveyed expected a cut of this magnitude and AUD lost ground across the board on this development and on the rally in government bonds yesterday. Nothing particularly dramatic was offered as guidance from Stevens and company, with dry statements about weaker than expected conditions and the expectation that inflation will eventually fall into the appropriate range by 2010 after peaking in this quarter, but taking some time due to the AUD weakness. From where we sit, AUDUSD looks quite resilient considering the news and we wonder if a try toward 0.7000 is in the cards on the other side of the US election results.

The bond rally also lent JPY some support just as USDJPY was nearing the psychologically significant 100.00 level yesterday. EURJPY is also lower, but relatively calm. The 10-day average true range for EURJPY is a remarkable 625 pips, so yesterday's relatively sedate 370 pips of movement seemed like a sea of calm. My, how times and our perspectives have changed. Just a year ago, the ATR was around 170, which was relatively high, especially considering that the reading in November, 2006 was as low as 60 - that was the heyday of the inflation of the carry trading bubble. So we've seen a 1000% increase in volatility in 2 years! Still, volatility has eased off slightly in these JPY crosses over the last few days on average and this would seem to raise the odds that we are transitioning into a more rangebound environment.

The US ISM Manufacturing number came out at a 26-year low of 38.9 and US Auto sales dropped to the lowest since the early 1990's, suggesting that Q4 growth numbers are going to be remarkably ugly. Again, we are very curious to see tomorrow's ISM non-manufacturing number, as it represents a far larger swath of the US economy. Still, the weak data is failing to rub off much on the US dollar so far as the growth story elsewhere is by no means any better. EuroZone final October PMI numbers were in yesterday adjusted even lower than the preliminary numbers showed last week.

We were a bit surprised to see the USD continuing to chug higher late yesterday and overnight with the significant event risk of the US presidential election results rolling in late tonight during the Asian session. Obama is expected to score a strong victory, with most analysis focused on how much of a mandate he can gain from this election. Analyzing the electoral college system (in which the candidate taking the majority of the popular vote in a given state gets all of that state's electoral votes, the number of which is based on the number of senators and representatives in that state), there is no way that Obama will receive the kind of mandate that Reagan received in 1980, when he took 489 electoral votes to Jimmy Carter's 49. McCain will take much of the South, a state or two in the Midwest and bits of the West and could come up with perhaps 175 electoral votes at worst to Obama's 350+. Much focus is also on how much of a majority the Democrats can win in the two houses of congress, particularly the Senate. The stronger the majority, the more likely that the Democrats are able to enact significant new measures that change the face of American politics more than they've changed since Reagan, a process that is ironically already well underway in the dying weeks of the Bush II administration. One analyst yesterday mentioned that Obama may be quicker than past victors to identify his cabinet - or at least Secretary of Treasury - due to the massive turmoil the markets have seen in recent months.

The question, of course, becomes: what is the market reaction? This is a tough one. The margin of victory suggested by the polls for some time now makes one believe that many participants have priced in an Obama victory, but has the entire world done so as well? If we use "Buy the rumor, sell the fact" analysis for the setup here, it would seem that the simple fact that we are approaching a major event risk and that the speculative market is already heavily long USD means that we could see a sizeable consolidation back to USD weakness. But let's see where thing stand tomorrow, we don't have much short term conviction here.

Chart: EURCHF

EURCHF has found less resistance than EURJPY, and we wonder if some of the continued financial services sector misery could continue to keep the CHF under a bit more pressure as long as equities are showing fewer signs of strain. Swiss Re, for example, was out this morning reporting far worse than expected Q3 results. EURCHF may have a look at 1.5000+ in the coming days as the 21-day moving average - much in vogue in many asset markets at the moment, including USDJPY and US and European equities- is up around 1.5060. The 55-day moving average is way up at 1.5610, but that looks awfully ambitious for now. All bets are off on a EURCHF rally if equities go into a fresh nosedive...

Published on  Tue, Nov 4 2008, 07:50 GMT