JPY and USD smashing stronger to new big levels overnight. Was this a capitulation or is there more to come?

• US Aug. ICSC Chain Store Sales rose 1.7% YoY vs. 2.5% in Jul.
• Japan Q2 Capital Spending fell -6.5% vs. +0.9% expected

• Norway Jul. Industrial Production (0800)
• Germany Jul. Industrial Production (1000)
• Canada Aug. Unemployment Rate and Net Change in Employment (1100)
• US Aug. Unemployment Rate (1230)
• US Aug. Change in Nonfarm Payrolls (1230)
• Canada Aug. Ivey Purchasing Managers Index (1400)
• US Q2 Mortgage Delinquencies (1400)
• US Fed's Yellen to Speak (1955)

Market Comments

The currency moves truly moved into parabolic mode on the big carry crosses as they often do when equity markets go into a tail spin. Yesterday, the S&P 50 saw one of its worst drops of the year and the VIX measure of equity fear/volatility shot higher. This put the JPY and CHF into overdrive very late in US trading. EURCHF accelerated its sell-off after 1.6000 had broken earlier in the day and EURJPY cut through figure after figure with a remarkable 700-pip range over the last 24 hours. We've seen a robust bounce in some of these crosses from early in the Asian session, but fear in the market is clearly very high and trying to call a bottom in the short term looks like a fool's errand for now. Markets are tough to trade in these kinds of situations.

The only thing that markets past can tell us about situations like these is that parabolic price action usually plays out very quickly - a matter of a few days at most - and is followed by a vigorous bounce - but from what level? In the face of a sheer cliff, there are few technicals we can rely on for indications of subsequent action.

Regarding yesterday's central bank action, the market seemed to underline the point yesterday that interest rate differentials are of fading influence in determining currency levels for now. Trichet, after all, put on a relatively hawkish performance, underlining that the ECB still had "no bias" and continuing to harp on the risks of second-round inflation effects. The ECB is also establishing tougher rules on its liquidity facilities by increasing the haircut on asset-backed bonds in which the assets are of dubious quality used in exchange for the liquid and highest rated ECB bonds. The new rules won't go into effect until next February as the ECB is telling the markets that they can continue to get cheap liquidity until then, but that they will have to get their houses in order by the time the new rules take effect. This will doubtless have big consequences for many banks down the road as well as the European credit market broadly. The press especially focused on the risks to Spanish banks, which are obviously using real-estate assets as backing for the liquidity they seek. Some are even saying that Spain will be forced out of the EMU eventually (hmm....what is the status way down the road for the single currency if central banks become afraid that the EMU as an institution is under threat....)

Now on to the US employment report for today: the market already has fairly low expectations for this report. Last time around we predicted that the unemployment rate was at risk of a bigger acceleration higher than expected and we were proven right. We call for this scenario again today. Consensus is looking for an unchanged reading of 5.7%, but we see upside risk to this figure. One of the main reasons besides the recent continued very high levels of claims and the weakening of the ISM non-manufacturing Index's employment subcomponent is simply the history of this indicator, which tends to head sharply higher in the middle phases of a worsening employment picture. We would not be surprised to see over 6.0% unemployment by the end of the year and over 7.0% by mid next year. Some observers point out that the broadest definition of unemployment has already preceded the previous peak from 2003.

The question is whether the market really cares about the US data and what is driving the market in general. The most plausible argument is that this continues to be a global deleveraging trade as the growth environment weakens, which tends to favor those currencies that performed worst when the credit bubble was at its height (JPY and CHF, for example). The market is moving to the bigger picture from the nitty gritty central bank moves and how interest rates are moving in comparison to one another from day to day. Also, the need for the European central banks to be more wary of wage deals linked to inflation levels means that the market is perhaps starting to see higher rates in Europe as increasing the risk of a harder landing and that the more flexible US economy will work its way. Still - plenty of negatives are likely on the horizon in the US economic picture, and we also have the uncertainty of a presidential election approaching, so a more two-way market in the USD pairs is likely to develop sooner rather than later.

Chart: EURJPY
Does the train stop here? It has so many times in the past, but momentum looks awfully scary. Interesting to see that we are at the 200-week moving average in the pair - which was last crossed in early 2002! Eventually this pair is likely to work lower, but two-way volatility is very dangerous at present...