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More market fireworks as Paulson plan for troubled US assets triggers enormous rally in risk appetite. But how long will it last? Short term moves look impressive, but endless questions will ensue once the excitement dies down. Churning market likely to continue churning... MAJOR HEADLINES – PREVIOUS SESSION oUS Sep. Philadelphia Fed out at 3.8 vs. -10.0 expected oUS Aug. Leading Indicators out at -0.5% vs. -0.2% expected oNew Zealand Q2 Current Account Balance out at -3.91B vs. -3.42B expected oGermany Aug. Producer Prices out at -0.6% MoM and +8.1% YoY vs. -0.5%/+8.3% expected THEMES TO WATCH – UPCOMING SESSION Key Risk Events (All times in GMT) * US Fed's Evans to Speak (1700) * UK Sep. Rightmove House Prices (Sunday 2301) * Japan BoJ Monetary Policy Meeting Minutes (Sunday 2350) Market Comments Yesterday we stressed the need for quick and coordinated action and that's just what we got - just as we were going to press. Key Central Banks announced a huge effort to create enormous swap lines to improve access to USD, which have been in intense demand around the world due to short term liabilities in the US that require funding, which no one has been willing to extend. As the day progressed, it didn't appear that this announcement was having much effect, however, and US equities sold off at the open to new lows. Then, later in the day, news came across the wires that the Secretary Paulson was working on a plan to do something about the troubled assets creating so much havoc in the financial world and that the solution would involve the creation of a Resolution Trust Corporation- style entity (this was the description given to the solution by the media: in reality, the plan as we understand it bears little resemblance to the RTC). This was the spark that created the hope that this crisis will ease and the S&P 500 has shot up a head spinning 100 points from yesterday's lows as of this writing +8.8% in less than 24 hours! Or is it hope? Of course, there must be some measure of hope out there that the shorter term crunch will ease here, but the timing of this move couldn't be more interesting for the markets, as we have the quarterly "triple witching" of financial futures contracts, options on those contracts and options on equities. Add on to this the across the board ban on naked short selling and we have to ask ourselves how much of this rally was caused by fresh longs and how much was simple "position offsetting" - a massive short squeeze, in other words. This will take some time to sort out. To add to the questions of the "validity" of the rally, it has emerged that the SEC is even considering a ban on ALL short selling, not just the naked variety. The Paulson plan is still just a plan, as it must still be reviewed by Congress and there are many loose ends. Will the tsunami of events overwhelming US lawmakers get them into action before the US election? Do they even understand the problem enough to use this for partisan positioning ahead of the election (in just a few weeks!)? Can the markets stand to wait until next year to see this resolved? These are important questions to which we don't know the answers. The specifics of Paulson's plan go to the heart of the problem: mark to market accounting and the way that deflating assets are impairing financial institutions' balance sheets in a self-reinforcing negative spiral. The plan would create a government fund of some $800 billion that purchases mortgage-backed securities directly from the financial institutions at a discount (how on earth do they price this??) and possibly even creating a fund of several hundred additional billion dollars to stabilize money market funds and insure deposits through the FDIC. Of course, the hope is that with liquidity pressures suddenly relieved on the industry, home pricing can quickly find a floor and that this would not involve a huge financial loss to the US government, and therefore taxpayer. We won't know for years how well this will work and what the final cost will be. Further down the road, the market is going to ask what the implications of the eventual solution are for the US government's credit rating as the Fed's balance sheet suddenly takes on board assets of unknown value in titanic portions. At this very moment, the market is rushing to buy USD on this relief move, but we are still very much biased on the glass half empty side of the equation for the medium/longer term (in terms of the prospects for continued risk aversion and global deleveraging rather than on the USD strength/weakness). What does this all mean for FX rates? Direction changes have been so large and frequent that trading in the shortest term is a casino-like proposition. No one has the answers at the present time. As long as this vein of relief continues to be rich, we could see further expression of risk appetite and unwinding of bets of further risk aversion (a bounce in the USD and higher yielders and sell-off in the CHF, JPY). But the "second guessers" could also come on-line quickly in coming days with an equally volatile backlash countering the latest moves as new questions swarm and due to the general cloudiness of the crystal ball. In other words, this is uncharted territory - there is nothing in the past to compare this situation to, so treacherous and two-way volatility is likely to continue in the short term. For longer term moves, we would like to see volatility falling and then follow the price action for clearer indications of the next trend emerging somewhere down the road. For now, let's get through the triple witching phenomenon today and keep an eye on how the key credit spreads react to this news in coming days/weeks. If the spreads don't come in and these measures are still unable to get the financial system "unstuck", then all bets are off for further risk appetite and we could quickly go back to meltdown mode...AUDJPY will perhaps remain the markets best "FearMeter".... If you prefer to trade something that moves a bit more sedately however, have a look at EURCHF as a lower-beta cousin. As always, be careful out there.... Risk warning Saxo Bank A/S shall not be responsible for any loss arising from any investment based on any recommendation, forecast or other information herein contained. The contents of this publication should not be construed as an express or implied promise, guarantee or implication by Saxo Bank that clients will profit from the strategies herein or that losses in connection therewith can or will be limited. Trades in accordance with the recommendations in an analysis, especially leveraged investments such as foreign exchange trading and investment in derivatives, can be very speculative and may result in losses as well as profits, in particular if the conditions mentioned in the analysis do not occur as anticipated. Please read our full Analysis Disclosure & Disclaimer at www.saxobank.com/analysis/disclaimer. Next Analysis:
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