After sharp new record low in the USD yesterday, the market dives into risk aversion mode ahead of Central Bank bonanza

Lots on the menu today with possible UK rate cut, Trichet press conference and Fed testimony. The carry trades may stay under pressure.

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• New Zealand Q3 Unemployment Rate fell to 3.5% vs. 3.6% expected and 3.6% in Q2
• Japan Sep Machine Orders fell -7.0% vs. -0.9% expected
• Australia Oct Employment Change out at +12.9k vs. 20.0k expected
• Australia Unemployment Rate out at 4.3% vs. 4.2% expected
• Japan Oct Machine Tool Orders out at +16.1%
• Switzerland Oct Unemployment Rate out at 2.6% vs. 2.5% expected.

THEMES TO WATCH – UPCOMING SESSION

Key event risks today (all times GMT):

• UK HBOS House Prices (0800)
• Sweden Sep Industrial Production and Orders and Activity Index Level (0830)
• UK BOE Announces Rates (1200)
• ECB Announces Rates (1245)
• Canada Housing Starts (1315) 
• ECB's Trichet Holds Press Conference (1330)
• US Fed's Bernanke Testifies About US Economic Outlook (1500)

Market Comments

The world finally makes a bit more sense this morning as the huge risks to global growth that we have seen developing over the last few weeks (spiking crude, credit worries, struggling USD, nervous equities) finally turned a nervous market into one that rushed for the exits. Equities were smashed, carry trades swooned, bonds rallied and USD/CAD rallied as much as 3.5% in a remarkable 12-hour period late yesterday and overnight. CHF and JPY were the big winners on the day and may continue to carry the banner in the days ahead as the market has switched a bit from "USD only" mode, to risk mode. The USD, in fact made sharp gains against the go-go "other dollars" late yesterday and overnight where the market has overextended its greed of late.

It also makes sense that the market sees a big pivot point now with the need to recognize today's very busy Central Bank schedule and its potential to recalibrate the market's forward rate expectations.

ECB: recent noises from Trichet and company suggest continued strong concerns on the inflation front (as buttressed by the recent high EuroZone CPI estimate for October). But will yesterday's 1.4700 print in EUR/USD put a muzzle on Trichet's vigilance as it certainly should? Our best guess is that he will indicate as much worry as possible on inflation but at the same time not making it appear that the ECB is ready to act any time soon.

BOE: in our estimation, the BOE should cut as we have recounted the risks to the UK economy imposed by the credit market worries and a potential recession in the financial services industry, combined with overstretched UK consumer and potential for outright falls in UK housing prices going forward. An overvalued currency and lousy terms of trade are no big boost either. Odds are low for the cut, but we still call for it - and the reaction should spark a sharp sell-off in GBP if a cut is announced. If the BOE keeps rates steady, EUR/GBP could be headed for more rangebound limbo, and we would sell puts/buy on any sharp sell-off in the days ahead if this unfolds.

Fed: Bernanke is in the hot seat once again as we must look for the Fed's wording on its view of the economy and on the dollar. Bernanke's outlook has been generally positive considering the circumstances and the recent cuts. If he expressses enough optimism that the rate cut medicine already administered is sufficient for now AND that inflation is a significant concern AND recognizes the risks of a weak USD, then there is potential for a sizeable USD consolidation to the stronger side. A blatant neglect to mention any risks imposed by the weak USD, and we could see another leg down for the USD, especially versus the likes of JPY and CHF.

The spark for the huge CAD sell-off late yesterday was supposedly the Ontario PM's call for the BoC to cut rates, but really it was more likely about a serious bout of profit-taking in a heavily positioned market and as risk aversion (which should favor a weaker CAD on global growth slowdown fears) finally took firmer hold. We may or may not have seen the bottom for now, but the market is likely to become a much more two-way affair for some time.

So again, the market axis revolves around risk and carry, and the poles are the low yielders (JPY and CHF) and the higher yielders (AUD, NZD and CAD, even if its yield not so high, and especially EM currencies where price action could be explosive in this environment). Volatility wise, the risk is largest to the downside for carry trades on any given day as these always have an assymmetric volatility profile. 

Charts: USDJPY - ready for the abyss or will it hold the line? EURAUD and NZDJPY - another look at the carry trades. These charts are very similar, as they are basically inverse versions of the same thing, so pick your flavor of risk appetite.

USDJPY is approaching very interesting levels here as 111.60 approaches. If that level falls, we could be looking at a try towards 105.00 eventually. Key resistance ahead of 114.00.

EURAUD - AUD beginning to look weak against the broader market with a false top versus JPY, EUR and CHF. The AUDUSD chart also saw an interesting shooting star pattern yesterday, so i you dare take a USD view, there could be further downside on that bearish reversal pattern as well. For EURAUD, note the false break lower and that the pair is breaking the first line of resistance just above 1.5800. A bit higher, the descending trendline looms. Is this one ready for a big extension higher after testing key multi-year support levels at 1.5500? The risk aversion will need to keep up a head of steam to keep this one heading higher.

NZDJPY - here we see another classic bearish engulfing candlestick pattern yesterday and the interesing 55-day SMA coming up at 85.47. The minor rising consolidation line was also taken out yesterday and the 200-day SMA was taken out this morning. If this one breaks lower through 85.50 and the risk aversion keeps up, we could see 84.00 and even 81.00 eventually.

Note: the support/resistance levels used in the matrix’s of this document are levels derived from yesterday high, low and close. Reference in the text to other support/resistance levels will occur.