Carry trades snap back higher on huge equity rally. Key US inflation and Retail Sales data on tap

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• US Oct Pending Home Sales rose 0.2% vs. a drop of -2.0% expected
• New Zealand Q3 Producer Prices - Input/Output out at +2.3%/1.6% vs. 1.1%/1.1% expected
• US ABC Weekly Consumer Confidence out at -17 vs. -16 expected
• Australia Nov Westpac Consumer Confidence dropped -4.2%
• Australia Oct Wage Cost Index rose 4.2% YoY as expected
• China Oct Retail Sales rose 18.1% vs. 17.0% exp.
• Germany's Q3 GDP rose 0.7% as expected

THEMES TO WATCH – UPCOMING SESSION

Key event risks today (all times GMT):

• France Q3 GDP (0745)
• ECB's Trichet to speak at event (0800)
• UK Sep Avg Earnings and Oct Jobless Claims Change and Claimant Count (0930)
• EuroZone Q3 GDP (1000)
• UK Bank of England Quarterly Inflation Report (1030)
• US Weekly MBA Mortgage Applications (1200)
• US Oct  Producer Price Index (1330)
• US Oct Advance Retail Sales (1330)
• US Fed's Bernanke out speaking (1410)
• New Zealand Sep Retail Sales (2145)
• New Zealand Oct Business PMI (2300)
• Australia Reserve Bank Monthly Bulletin (0030)
• New Zealand Non Resident Bond Holdings (0200)
• China Industrial Production (0200)

Market Comments

US equity markets got a big boost yesterday as one of Wall Street's titans Goldman Sachs claimed that it was weathering the subprime debacle quite well (the market decided to focus on this good news at least, as there were negative announcements elsewhere and Goldman itself said it expected that the credit crisis would worsen). Also,  WalMart earnings were bettter than expected and their holiday outlook is far more positive than the market has been fearing. This combined with a very large sell-off in crude, and the market had plenty of reason to toss fear aside for the moment and consolidate. In the FX market, this of course resulted in a big swing higher for the carry trade after its recent precipitous drop. Whether this rise can continue for the short term will likely be determined by the US data releases today.

US data today: PPI is an important inflation number, but perhaps less followed than the PCE Core and CPI. Still, today's expectation is for a new 2-year high at 2.6% after the index ticked back over 2.0% the last 3 months. More importantly, the Retail Sales data out today is expected at a mere +0.2% less Autos. There is a strong risk that this number comes in worse than expected as shopping center data released yesterday showed the lowest rate of YoY growth since 1995. The risk to calling a lower number is that higher gasoline spending from elevated prices sometimes obscures weakness in discretionary consumer spending areas.

Somewhat ironic in this environment is that highly negative US data could actually boost the USD more than highly positive data as negative sentiment and sharply weaker equities seem to be associated with the USD and JPY strength and positive sentiment seems to have the opposite effect.

As long as the market continues to look for a December cut from the Fed (fully priced in), the USD will have a hard time sustaining a rally unless equities sell off again, and even more importantly further out, unless we begin to see further signs of weak data elsewhere. The UK seems to be at the head of the pack in this area - but we look for further signs of deceleration from Europe soon. Today's GDP data from EuroZone is not very relevant for the forward situation, unfortunately.

We looked at the potential to play a lower volatility pair in selling EURSEK yesterday, which continues to show signs of reversing lower. The short term key for the pair is a close through the 9.2400/9.2350 area for a possible continuation to the 9.1000 area. The Riksbank minutes were supportive as the officials voted unanimously to raise rates to parity with the ECB rate and looked to hike them again at the meeting in December (as they seem less hamstrung by the weak USD situation). The risk is that SEK seems to be loosely correlated with the risk aversion theme, so if everyone is diving for the bomb shelters again, long SEK trades could sour.

Charts: EURCHF and GBPUSD

EURCHF is one of the classic risk appetite trades, and it finally showed signs of a bounce yesterday as it was closing in on the 55-week moving average. If the bounce in risk appetite continues here, there could be room for the pair to have a go at the 55-day SMA over the short term (shown as 11-week SMA). The bearish technicals would really set in if the pair breaks the old rising trendline and crosses the 55-week SMA and recent lows. We look for eventual confirmation of the bearish potential.

GBPUSD. The UK may be at the "head of the pack" in catching up to the US' economic weakness, and we see little further upside potential for GBPUSD for the cycle. The recent sell-off seems to have inflicted mortal damage on this chart. Still, we need to see some follow through below the 2.0500 area the 55-day SMA not far below to get confirmation that further weakness is in the cards and for appropriate trade triggers.

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.