Huge equity rally gives carry trades whiplash once again. USD pulling back after late weakness yesterday on Fed rhetoric

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• Fed's Beige Book: 7 of 12 districts reported slower growth in November compared to October.
• New Zealand Oct. Building Permits for Oct. out at -4.8% MoM vs. -10.2% drop in Sep.
• Japan Oct. Industrial Production out at +1.6% vs. +1.5% expected.
• Australia Q3 Capital Expenditure fell -6.5% vs. +2.0% expected.
• New Zealand Nov. Business Confidence was -19.6 vs. -12.9 in Oct.
• UK Nationwide house Prices for Nov. fell -0.8% MoM vs. +0.1% expected/
• France Nov. Consumer Confidence out at -28 vs. -24 expected.

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

• Sweden Q3 GDP (0830)
• Germany Nov. Unemployment Change/Rate (0855)
• Norway Oct. Retail Sales and Nov. Unemployment Rate (0900)
• UK Oct. Net Lending Sec. on Dwellings and Mortgage Approvals (0930)
• UK BOE's King and other members to testify (0945)
• UK CBI Nov. Distributive Trades Report (1100)
• Canada Q3 Current Account (1330)
• US Q3 GDP, 1st revision (1330)
• Canada Oct. Industrial Product and Raw Materials Prices (1330)
• US Oct New Home Sales (1500)
• EU ECB's Trichet and Juncker to speak (1700)
• Japan Oct Jobless Rate and CPI data (2330)
• US Fed's Bernanke to speak (0000)
• Australia Q3 Current Account Balance (0030)
• Japan Oct. Housing Starts (0500)

Market Comments

Yesterday was a day in which many of the recent themes were mercilessly squeezed to sort out the weak hands from the strong. US financial stocks, which have fallen some 25% since early October, closed up over 5% as the broader S&P500 rose about 3%. Looking at FX, this translated into a huge squeeze on long JPY and CHF positions, as USDJPY blasted back over 110.00. The star performers were the riskier corners of the market - the ones that have been most pounded over recent weeks. CADJPY rose 2.5% yesterday, even as oil was off as much as 9 dollars (!!) from the price just three days ago. AUD also was on a tear against. On the flipside, the risk averse CHF and JPY. A squeeze was perhaps overdue on this theme - considering the kinds of moves we've seen in crosses like CHF and JPY vs. AUD and CAD. The question we ask now is how long does it last. Best guess would be that we could see this sharp rally extend in the very short term, but that it may top out very soon as the underlying themes of global slowdown will not be going away any time soon.

The USD was lost somewhere in the middle yesterday, but was on the weaker side against most currencies into the close, as Kohn's rhetoric was almost completely at odds with the more hawkish words from Plosser and Evans just the previous evening. Let's see whether Bernanke's speech late this evening can give us any resolution. We may see little from the Chairman in terms of hints, as he is giving a speech at a local chamber of commerce and will be accepting an award. The specific trigger for the last leg of USD weakness late yesterday was the dovish Fed Beige Book, which stressed evident slowdown. The market was formerly beginning to develop the idea that the Dec. 11 rate cut was not a sure thing, but Kohn and the Beige Book quickly reduced the odds to nil on this and some extremists are even advancing the idea that the Fed will accelerate the easing with a 50 bp. cut. Still, the USD is holding up relatively well in today's trading and if this move for higher risk appetite proves short, then the USD may quickly find support. (Just before going to press here - about 30 minutes after initial comments, the USD has wiped out almost all of yesterday's losses, so it appears there could be more USD strength to come)

On the data front, watch out for the UK mortgage approvals data and CBI report, as well as the BOE officials's testimony at 0945. There is a gathering storm in the UK housing market and for the UK consumer, and credit conditions appear to be deteriorating rapidly. The Nationwide house number today is no surprise considering the trajectory of the RICS House Price Balance over the last several months, which has a near perfect record of advanced prediction of the Nationwide number (we've covered this subject in the past). If we see ugly numbers from the UK, the GBP sell-off could resume now rather than later. Short GBPCHF, short GBPJPY and short GBPUSD might be the basket of choice for this. The last of those three is the favorite...

Elsewhere on the data calendar, we suspect the US Q3 GDP adjustment (expected upward adjustment to 4.9% from 3.9% - how can this be?) is irrelevant and backward looking as everyone is looking at the Q4 projections. The US New Home Sales numbers will no doubt be terrible as usual, though stories of desperate incentives from suppliers could mean a surprising uptick or at least better than expected number. The Japanese CPI data is also of interest if it surprises to the upside.

Trading Strategies/Charts

Since the general outlook suggests that we should be looking at a way to fade this move in risk-willingness, we choose EURCHF as a barometer for where to get back on the risk aversion wagon. As the USD was spiking higher as this article was going to press, we decided to include a chat of GBPUSD, as we consider whether the top is in there...

EURCHF - In trending markets that become overextended, consolidations can be very sharp and large, but of short duration. We consider the prospect that the rally in EURCHF, for example, is largely over with after yesterday's sharp extension. A number of levels have come into play here. The first Fibo came in at 1.6492, which is almost exactly where the pair closed yesterday. The 200-day SMA (black) was traversed as well, and the 55-day SMA comes in at 1.6587. We would look for a turnaround in this pair below the 0.618 Fibo retracement level/55-SMA area as the broader picture suggests we are transitioning to a bear market, which would be full confirmed below 1.6300.

GBPUSD - have we finally seen a definitive reversal here. A close at these levels would form a pronounced reversal of the failed attempt above 2.0750 late yesterday. Look for the rising consolidation line to fall and then a try through the 55-day SMA (in red) for further confirmation that we may be entering a bear market in GBPUSD...