Carry trades pull back from the brink of key support - market remains nervous. EURUSD may be set to try at the recent top

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• US Nov NAHB Housing Market Index at 19 vs. 17 expected, and the Oct number was revised to 19 from 18
• Former BoJ official stated that the US subprime debacle kept Japan from raising rates.
• Germany Oct Producer Prices rose 0.4% vs. 0.3% expected
• Switzerland Oct Trade Balance out at +1.56B vs. 1.49B expected

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

• Norway Q3 GDP (0900)
• UK Oct BSA Mortgage Approvals (0930)
• UK Nov CBI Industrial Trends Survey (1100)
• Canada Oct CPI (1200)
• US Oct Housing Starts and Building Permits (1330)
• US Minutes of FOMC Meeting of Oct 31 (1900)

Market Comments

Yesterday, the market responded to the crescendo of worry evident in various risk meausures as equities sold off further and the Dow Jones Industrials average posted its lowest close since the mid-August credit crunch. FX responded with the JPY making gains and the commodity currencies struggling. But fading momentum was evident in the Asian session, as USDJPY bounced strongly from a marginal new 3-day low and EURJPY bounced back from the key 160.50 area support. Commodity currencies also pulled back from key support (see AUDUSD chart below). Apparently, some of the bounce was due to rumors of an emergency Fed meeting to cut rates, but also due to a bid for a Japanese bank by a US buyout firm With several days in a row of direction changes, this carry trade has become a difficult one. Meanwhile, EUR/USD has been biding its time in a narrow range and may have consolidated enough for an attempt at the recent and all-time top at 1.4750, but perhaps only if JPY remains rangebound.

The FOMC minutes are up today - let's see if they can offer the market any surprises. Although Fed rhetoric has very much begun to recognize the inflation risks inherent in continuing to cut rates in the face of a flailing USD, the market is still aggressively pricing in further easing from the Fed as this shift has seen little affect on actual rate expectations. The Fed Funds rate now stands at 4.50%, yet US 6-month treasuries just closed below the 3.50% threshold yesterday. This is an extraordinary expression of lack of confidence in the economy heading forward. The fixed income market is showing white-knuckle worry indeed. For the USD to get much support against the other majors, we would really need to see an easing of this worry relative to the yield curve in Europe. German 2-year rates fell sharply to 3.70% yesterday, but still are close to recent highs in yield vs US 2-year rates, which closed at 3.2% yesterday.

We also have US housing starts and building permits numbers today - the most forward looking of the US housing numbers, but we wonder if these will get much focus - as only shockingly good numbers would call into question the overall trend. Watch for the Canadian CPI figures today as these will be key for determining the prospects of a cut in rates by the Bank of Canada going forward. The BoC seems the most likely to follow Norges Bank in heavily adjusting growth and inflation projections lower due to a strong currency.

The general and rather difficult picture is this: global risk measures are still screaming a warning signal, but the markets have only partially responded. The short-term technical picture looks a bit choppy and rangy. Add to this the risk of thin markets with a very long US weekend immediately ahead and the short-term picture is difficult indeed. We still look for the risk aversion trade to reestablish soon.

Charts: EURUSD and AUDUSD

EURUSD has been quietly consolidating in a range as the focus has been on JPY crosses and the commodity currencies. If things remain rangebound on that front, the pair may have a chance at trying for the 1.4750 top if 1.4690 gives way. Still, the USD picture today could be jumpy with the FOMC minutes on tap.

 

AUDUSD - broke through the 55-day moving average, which was clearly serving as support, and further fell to test the even more important 0.8750 area, which is increasingly looking like a head and shoulders neckline. While the short-term bounce leaves bears disappointed and could lead to further short-term gains, the significance of the 0.8750 area has been underlined once again for this pair.