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GBP collapses on dour BoE report and prospect for lower rates

Thu, Nov 13 2008, 07:49 GMT
by John Hardy

Saxo Bank

Risk aversion back on the front burner again as US equity indices eye the lows for the cycle. JPY crosses seem a bit less panicky this time around.

MAJOR HEADLINES – PREVIOUS SESSION

• New Zealand Oct. Business PMI out at 43.5 vs. 46.7 in Sep.

• New Zealand Sep. Retail Sales out at +0.1% vs. +0.4% expected and ex Autos at -0.5% vs. +0.4% expected.

• Japan Oct. Domestic CGPI out at -1.6% vs. -0.9% expected

• New Zealand Oct. REINZ House Sales fell -34.8% YoY vs. -23.7% in Sep.

• China Oct. Industrial Production out at 8.2% vs. 11.1% expected

• Germany Q3 GDP out at -% QoQ vs. -0.2% expected

THEMES TO WATCH – UPCOMING SESSION

Events Today:

• Switzerland Oct. Producer and Import Prices (0815)

• Sweden Oct. Unemployment Rate (0830)

• ECB to Publish Monthly Report (0900)

• Switzerland ZEW Survey (1000)

• Canada Sep. International Merchandise Trade (1330)

• US Sep. Trade Balance (1330)

• US Weekly Initial Jobless Claims (1330)

• US Weekly Crude Oil and Product Inventories (1600)

• US Fed's Plosser to Speak (1700)

• US Fed's Stern to Speak (1900)

• New Zealand Oct. Non-resident Bond Holdings (0200)

Market Comment:

The BoE was out yesterday with its quarterly inflation report, and Mr. King's turned in an ultra-bearish performance, forecasting that national income would drop by almost 2% on year on year comparisons by Q2 of next year and that the overall economy would shrink as much as 1.3% in 2009. This would mean that BOE rates are likely to eventually fall below 2.00%, meaning a multi-century lows. Yesterday also saw the release of unemployment data that shows the employment situation reaching its worst levels in 11 years. The combination of a very low interest rate outlook on accelerating negative economic indications and renewed trouble in the financial sector has the pound experiencing the most pain in this environment. GBP is now scraping along at a 12-year low on a trade-weighted basis. EURGBP blasted through 0.8200 and posted new highs above 0.8400 before finding resistance. There may have been barrier options involved in some of that action.

US Treasury Secretary Paulson announced yesterday that the US government is abandoning the plan to lift toxic assets off bank balance sheets by buying them in the open market, and will instead focus more on bank recapitalization, propping up debt markets related to consumer credit and trying to prevent mortgage foreclosures. This announcement added to the uncertainty already plaguing the market as it is increasingly clear that the fiscal response to the ongoing crisis just balloons larger and large with no end in sight. Financials were especially hard hit by the news and some of the risk indices are widening again (credit, emerging market and mortgage spreads).

Still, there are a few divergences in this cycle of risk aversion relative to the last big liquidation move that ran for the balance of the month of October. Namely, while US equity indices are close to their lows, the JPY crosses still have a way to go before they reach the lowest levels in late October, and EURCHF is one of the more glaring divergences, as it is still well north of the 1.4300 low. For the latter cross, this may have something to do with the market factoring in financial/banking troubles as a CHF negative that wasn't added to the calculation in earlier cycles when the market simply sold EURCHF as a knee-jerk trade on any sign of risk aversion. (Specifically, UBS is in the spotlight due to the US indictment of one of its top executives)

There are three ways to read the divergences more broadly: first, that previous moves were simply overdone and that nibbling at some of the risk appetite trades (AUD crosses and perhaps EURCHF) on dips is one trade tactic worth pursuing. Second, the action may simply be suggesting that risk aversion could continue, just in a choppier and slower fashion as momentum comes out of the market. We may get an answer to this question in the coming few trading days before and after the G20 meeting this weekend as the market decides how it wants to play the riskiest end of the market: the emerging market currencies. Third, the divergences could be a sign of CB intervention (at least for JPY and AUD pairs), as Japan explicitly sought a G7 statement that gave it a green light to intervene, and it is heavily rumored that the RBA has been intervening - more on this below. The intervention may be looking to avoid huge volatility rather than targeting specific levels over a sustained period of time.

It appears that EURUSD and the S&P500 are the two major instruments tracking each other most closely at the moment and at this inflection point (close to recent lows), we are likely either faced with a sizeable new leg down or support that leads to a more rangebound outlook in the coming weeks. EUR was perhaps artificially propped up by all of the EURGBP flow going through yesterday and would seem vulnerable to further downside this morning for at least a retest of the 1.2330 lows after the ugly German GDP announcement this morning as this was going to press.

Chart: AUDUSD

Traders report that the RBA was out intervening to support the AUD when AUDUSD hit 0.6350 overnight. If the move toward risk aversion continues, the RBA may have to get busy again.
Traders who believe that the RBA will be successful in intervention efforts may want to have a look at shorting the EURAUD cross. For now, AUDUSD looks very uncertain in the very wide range between 0.6000 and 0.7000.

Published on  Thu, Nov 13 2008, 08:02 GMT