JPY crosses find strong support as Asian equities rally into the close after initial weakness.

USD view still uncertain as we've yet to see follow through on recent strength. Is the US University of Michigan sentiment headed for lowest reading since 1992?

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• US Dow Jones Industrial average closed down over 300 points to a 10-month low
• New Zealand Nov. Retail Sales out at 2.0% and 0.9% ex Autos, vs. 0.7% expected for both.
• Australia Q4 Import Price Index rose 0.2% and Export Index fell -0.6%
• Japan Dec. Consumer Confidence fell to 38.3 vs. 38.5 expected and 40.0 in Nov.
• Japan Dec. Nationwide Department Store Sales fell -2.3%

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

• UK Dec. Retail Sales (0930)
• Australia RBA's Stevens to Speak in London (1320)
• Canada Nov. Manufacturing Shipments (1330)
• US Jan. preliminary University of Michigan Sentiment (1500)
• US Dec. Leading Indicators (1500)

Market Comments

World equities follow through lower with a bang yesterday, as the major US indices closed off over 2%. The triggers for this included a fall through key technical levels (1370 in the SP500 was one of these), additional bad news from the banking sector with the Merrill Lynch earnings, worries over the implosion of bond insurers Ambac and MBIA, US housing starts showing a further deceleration of activity, and the worst Philly Fed reading since late 2001. That last reading suggests a heavily contracting manufacturing base in the Philly Fed region. Curiously, however, the currency market took these developments mostly in stride. There was a sharp response to the risk aversion in the JPY crosses, but these bounced again heavily overnight as equities also found some strong support in Asia after an initial sell-off. The USD treaded water as the key short term support just below 1.4600 in EURUSD is still in place.

The trading environment is very tough here as the moves are very jagged - with harrowing retracements within an overall directional move. This makes trading and stop placement difficult. JPY crosses look particularly unreliable at the moment, as we saw another large bounce from a sell-off overnight that makes us wonder if the JPY trade is going to be an ugly, churning one, rather than a big swoop to the upside like we've seen in markets past. The EM corner of the market seems to be seeing the most dramatic moves in the last few sessions, with many key USD/EM crosses blasting higher - particularly USDZAR.

Bernanke voiced his support for a stimulus package before congress, with the usual caveats of fiscal responsibility, etc. Market commenters subjectively commented on his demeanor - calling it somber or dour. Of course, the chairman refused to describe the economy as recessionary - even predicing a recovery in late 2008, but the moral support for such a stimulus package is a strong sign of concern from the Fed that further weakness lies ahead.

One reason that economics is called the dismal science is that the most important driver of the economy is the sentiment of its participants - and sentiment/confidence is simply not reducible to empirical principles. The Michigan Sentiment reading is nearing its post-Hurricane Katrina lows and has been falling all year. If it notches a fall of just a couple more points (below 74.2), it would be the lowest reading since 1992. And if sentiment continues lower and stays there, we will see a recession in the US. The forward interest rate market is already predicting it.

NZD found support on a very strong Retail Sales report overnight - but may still be a sell on bounces in the bigger picture in the day/weeks ahead.

Charts: GBPJPY

GBPJPY: We're no fans of trying to pick highs and lows, but the downside momentum on many of the JPY crosses is fading, with stochastics beginning to rise, and it appears that the risk of a consolidatory move higher is rising here - even if we believe that the overall downtrend will remain intact. A lower volatilty way of playing this same trade (likely to correlate heavily with it) is EURCHF. A bounce could see GBPJPY back towards the first big Fibo just under 216.00 if first resistance at 212.38 falls.