JPY and CHF smashing stronger across the board as stock markets swoon. Commodity currencies looking vulnerable.

USD performs well considering terrible Retail Sales. But how would it react if the Fed delivers an intermeeting cut?

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• US Weekly Consumer Confidence dropped to -24 vs. -21 expected and -20 previously
• Australia Jan. Consumer Confidence dropped to -8.3% from +1.8%
• Japan Dec. CGPI was out at 0.4% vs. 0.1% expected
• Japan Nov. Adjusted Current Account Total out at JPY +2164.5B vs. JPY +2045B expected
• New Zealand Dec. House Sales fell -32.1% YoY vs. -21.6% in Nov.
• UK RICS House Price Balance out at -49.1% vs. -45.0% expected
• Australia Nov. Home Loans out at +4.0% vs. +1.0% expected
• New Zealand Dec. Non-resident Bond Holdings rise to 76.2% vs. 74.3% in Nov.

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

• UK Dec. Claimant Count Rate and Nov. Avg Earnings (0930)
• EuroZone Dec. CPI (1000)
• US Dec. CPI (1330)
• US Nov. TICs Data (1400)
• US Dec. Industrial Production and Capacity Utilization (1415)
• US Weekly Crude OIl and Product Inventories (1530)
• EuroZone ECBs Trichet to Speak (1855)
• US Fed's Beige Book (1900)

Market Comments

Yesterday was a day to remember for global markets as equities were pummeled to new lows on the year and the risk aversion trade was on across the board. First Citi earnings were out, with the US bank showing a massive and far worse than expected Q4 loss, as well as writing down $18+ Billion dollars on mortgage related securities and slashing dividends. This news was absorbed fairly well by the market, but then the far worse than expected US Retail Sales soured the mood and stocks were dumped across the board. The DAX swooned through its 200-day moving average and closed below for the first time since mid-2006. Intel added insult to injury after the close with a disappointing earnings report, and the risk aversion accelerated further. JPY and CHF powered higher everywhere, and AUD and NZD finally stopped ignoring the general move in risk aversion and were the hardest hit of the G10 on the day.

EUR was also under heavy pressure as EURJPY fell through key levels. Despite Trichet's remarkable hawkish perorations last week, Euribor futures have been nothing but a rocket ride to the upside this week, far outpacing the meager further gains in the US EuroDollar STIRs (where traders long ago moved into Helicopter Ben mode.) In fact, the outlook for Fed easing, judged by the spread between current Fed Funds and the interest rate on 2-year US T-notes - at over 175 bps today, is at the highest level since the early 1980's, when the Fed Funds was at an absurd 15%. Again we ask the question - how much more aggressive on Fed easing can the market get and how much bad news for the USD is already priced into the market? Our proposed answers: "not much" and "a lot".

Considering the weak Retail Sales data, the USD performed very well and yesterday gave us a very strong sign of diminishing returns on further negative news from the US. This is beginning to look USD bullish. We were looking for a 1.5000 test in EURUSD after last week's ECB performance, but that scenario is a bit more iffy after the rally fell short yesterday. Still, nothing looks certain at this point in time, and we'd need to see EURUSD back down through 1.4650 and the dollar index up through its 55-day SMA to get a firmer reading that USD strength will have legs. Another key test for the USD would be the market's reaction to a surprise 50 bps cut ahead of the Jan. 30 meeting, if it materializes.

GBP on a weak footing again overnight as the RICS House Price balance came out at -49.1%, the lowest reading in 1992. This together with the horrors of the banking industry meltdown will continue to keep GBP under pressure for a long time to come, though it is difficult to judge how much momentum the move can maintain in the short term.

Lots of event risks from the US today - with the most important perhaps being the Beige Book as the market has decided that the Fed doesn't care about CPI data.

Charts: AUDUSD and NZDJPY

AUDUSD: As the fear of a global slowdown takes hold, commodities are beginning to see losses in places, and the commodity currencies may come under the most pressure in this environment. AUDUSD saw a huge bearish engulfing candle yesterday and an apparent rejection of the move back above the 55-day SMA (in red). Also worrying for AUD was news out that Rio Tinto announced a 65% increase in copper output. This is a worrying sign that production may finally be catching up with demand in base metals, just as demand is about to sharply ease with a global cooling. The unwing of AUD longs could get ugly if current themes continue.

NZDJPY: almost all of the cross/JPY charts are looking ugly. Here, we see that NZDJPY is falling through its rising trendline on a longer term chart. Again, in this nervous environment, the carry trades should suffer the most, so the unwind here could get ugly.