Carry Trades bounce from sell-off again as US stock index futures rose after ugly close yesterday.

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• US based Citigroup announced that it will sell the Abu Dhabi Investment Authority USD 7.5B in equity units to shore up reserves.
• Japan's economic and fiscal policy minister Ota said that Japan's battle with falling prices is ending
• Japan Oct Corporate Service Price index rose 1.4% vs. 1.5% expected (YoY)

THEMES TO WATCH – UPCOMING SESSION
Key event risks today (all times GMT):

• France Nov. Business Confidence Indicator and Oct. Housing Starts (0745)
• Sweden Nov. Manufacturing and Consumer Confidence (0815) 
• Switzerland Oct. Producer and Import Prices (0830)
• Sweden Oct. PPI (0830)
• Germany Nov. IFO (0900)
• US Sep. and Q3 S&P/Case-Shiller Home Price Index (1400)
• US Nov. Consumer Confidence (1500)
• US Fed's Plosser to speak on Economic Outlook (1720)
• US Fed's Evans to speak on US Economic Outlook (1830)
• US Weekly Consumer Confidence (2200)
• Japan Oct. Retail Trade (2350)

Market Comments

The market reached near panic levels again late yesterday as US stocks, particularly financials, were tanking yet again into the close, spoiling the rise seen on the Friday after Thanksgiving last week. Then overnight we get the announcement that Citigroup would receive a large infusion of capital from Abu Dhabi Investment Authority. Since this news item hits at the core of everything driving markets of late - fear of a systemic financial problem driven by US financial institutions - we got a big bounce in global markets. USDJPY, after touching a new recent low well below 107.50, suddenly spiked to 108.80. US rates also bounced overnight. With a reaction like this, the market is clearly getting heavily positioned for further JPY strength and risk averse trades in general, and it goes to show the volatility risks in the market. It is still just a news item, however, and does it really change the underlying picture?

So how long does the bounce last? Ad hoc new items can create lots of movement that reveal the market positioning and trigger stops, but if nothing else of interest materializes and we don't see immediate follow-through, then the market can quickly get back to doing what it was doing before. So, while the risks of a short term rally in the carry trades is there, we prefer to look for confirmation that the risk averse trade is back on. Using USD/JPY as a barometer, any move above 109.10 could raise the risks of a further run for carry towards 111.50 in USDJPY, while a swing back below the 107.80 downside swing level tells us that the Citi story was just a temporary diversion.

Trichet and the EU delegation are trying to impress upon the Chinese the import of allowing their currency to strengthen as they suggest the risk of protectionist tendencies increasees as long as the problem remains unaddressed. Not surprisingly, the Yuan has been allowed to strengthen fairly sharply against the USD this week so far. It would bad form for the Chinese to allow new highs in EURCNY while the EU delegation is visiting, so if it is rallying in the coming few sessions, we could see selling the PBOC on the offer in EURUSD.

Watch the German IFO today, as one wonders if the market will ever begin to react to the weakening trajectory of European data. If the JPY begins to strengthen again and the IFO is weak, the focus could begin to switch more to EURJPY from USDJPY. If 159.50 gives way in EURJPY again, there's not much on a technical basis to hold it back from big additional losses.

Also watch the Fed speakers for signs that the Fed is worried about inflation - the market has been ignoring this lately!

Trading Strategies/Charts

The technical uncertainty is rather high across the board here. Take AUDUSD, for example. We saw another run at the lows yesterday below 0.8700 before seing a big bounce overnight. AUDUSD recently traversed important support at 0.8750 without really following through lower just yet. At the same time it hasn't rallied enough (55-day SMA comes in below 0.8900 now) to make us think that it has rally potential either. Give us a sign, either way!

USDCAD - has been an interesting one to watch of late, as the market has begun to make bets that the Bank of Canada will cut rates and as the reaction to high oil prices has faded. The remarkably low short-term volatility after the unprecedented previous volatility (how often do you get 10% bounces in currency pairs in just 7 trading days?) could just be the quiet before another storm. In this case, the pair has failed to consolidate to the downside, this could mean a sharp further extension north of parity once more. Watch the 0.9925 level for a technical break. Possible target higher is 1.0175 on a break (0.618 Fibo retracement).

EURJPY - has been hopelessly indecisive of late as continues to flirt with the 55-day SMA (red) and 200-day SMA (black). The break of the rising trendline has so far not been confirmed. But a fall back through 159.50, an important flatline support level of late, and then 158.70 could open up significant downside for the pair, especially if today's IFO release is sharply weaker. If EURJPY is tanking, it could cap EURUSD for now as well.