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The USD saw a brief spell of weakening yesterday

Thu, Nov 20 2008, 08:05 GMT
by John Hardy

Saxo Bank

More to come if Dow capitulates through 8000 in near term. EUR weakness should continue as long as rate differentials with USD and JPY continue to contract.

MAJOR HEADLINES – PREVIOUS SESSION

• Japan Adjusted Merchandise Trade Balance out at -¥175.6B vs. +¥71B expected

• Germany Oct. Producer Prices steady at 0.0% vs. -0.7% expected

• Switzerland Oct. Trade Balance out at 1.84B vs. 1.28B expected

THEMES TO WATCH – UPCOMING SESSION

Events Today:

• UK Oct. Retail Sales (0930)

• Canada Sep. Wholesale Sales (1330)

• US Weekly Initial Jobless Claims (1330)

• US Nov. Philadelphia Fed (1500)

• US Oct. Leading Indicators (1500)

• US Fed's Kroszner to testify before Congress (1500)

• US Treasury Secretary Paulson to Speak (1900)

• US Fed's Bullard to Speak (0200)

• Japan BoJ Target Rate (no time given)

Market Comment:

The USD saw a brief spell of weakening yesterday after the Fed's Kohn was out telling the market that the Fed is already engaging in quantitative easing - a technique of flooding the market with liquidity and a tool that central banks employ when CB rates have already essentially reached zero. This was the same tactic that the BoJ employed in recent years when it had a zero-interest-rate-policy (ZIRP). All talk of whether the Fed is to cut rates further is irrelevant at this point, as the de facto funds rates has often approached zero of late. (Side note: can anyone find an analyst who predicted more than 2 years ago that this would end in the US engaging in quantitative easing - it's amazing to step back from it all once in a while and realize how far we have come.) One argument against the Fed officially lowering the funds rates much further is that keeping the funds rate positive, even at a meager 0.50% - 1.00% level, allows the Fed to pay interest to banks that deposit funds with the Fed and therefore "add money" to the system in this roundabout way.

We pulled out some of our old rate differential charts for a look at how rate spreads on the 2-year German notes were faring vs. US and Japanese counterparts. It is clear that the massive unwinding of ECB expectations is coinciding with the shrinking of the 2-year spreads as the market prices in more and more easign from Trichet and company. This process is not necessarily complete, and there is still plenty of room for a further capitulation from the ECB.
The German-US 2-year differential at present is still over 100 bps - down from almost 200 bps in July. This differential could easily drop to 50 or below in the near term. The same goes for German vs. Japanese rates, which could have further to fall and already suggest that EURJPY should be trading at new lows right now.

The US CPI was out yesterday and showed a record drop of -1.0% on a month-to-month basis and helped buttress the strength in long government bonds, something we've discussed much of late. The US 30-yr. T-bond had its lowest close in modern market memory and US 2-year notes closed at a record low just above 1.00% . Building permits also notched a new low in October, basically matching the previous low in 1974, when the population of the US was about a third smaller. These low building permits and housing starts numbers are important for bringing balance back into the housing supply for the USA, which still must be worked much lower in the coming quarters if it is to returnt to historic norms.

The Australian central bank was rumored to be on the bid again near this 0.6350 area overnight, but it would seem that with equities in a meltdown mood, they will need to start choosing lower levels to come in and buy AUD - it should be trading much lower in this environment.

EURCHF: why is it this high? Rumors were flying about USDCHF related barriers yesterday around 1.2100, which have obviously fallen now, and USDCHF has recentely moved through its 200-week moving average around 119.70, so the USDCHF focus and recent range trading could be one of the reasons for EURCHF's ability to shoot higher and higher recently (and stopping out a likely overpositioned short market) But surely at these levels, the weak hands have been stopped out and we should be focusing on lower levels from here?

Chart: EURUSD

EURUSD performed a classic "head fake" as a basketball player would call it, popping it's head higher through clear technical triggers at recent highs and the pivotal 21-day moving average before plummeting into the close. This created a classic reversal formation and potentially sets up a test through the rising line of consolidation and then the 1.2330 area lows and on to perhaps 1.2000 as long as the pressure in equities is on. EURJPY may prove, as usual, to be an even higher-beta play for EUR weakness.

Published on  Thu, Nov 20 2008, 08:33 GMT