JPY sharply stronger across the board as 100.00 USDJPY level sees first test. JPY crosses set to tumble?

US Retail Sales on tap today, but market more focused on risk theme again on hedge fund failure news.

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• New Zealand Feb. Business PMI out at 52.2 vs. 53.2 in Jan.
• New Zealand Jan. ex-Auto Retail Sales out at +0.3% vs. +0.1% expected
• Australia Feb. Employment Change rose +36.7k vs. 15.0k xpected
• Australia Feb. Unemployment Rate fell to 4.0% vs. 4.2% expected and 4.1% in Jan.

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

• Sweden Feb. Unemployment Rate (0830)
• Canada Q4 Capacity Utilization (1230)
• US Feb. Import Price Index (1230)
• US Feb. Advance Retail Sales (1230)
• Switzerland announces 3-month Libor Target Rate (1300)
• Norway Norse Bank Announces Deposit Rate (1300)
• New Zealand Feb. Non-resident Bond Holdings (0200)

Market Comments

The market continues to up the ante on the Fed, as Tuesday's dramatic announcement of new liquidity enhancement measures by the Fed failed to impress for even 24 hours and the market quickly put back on the risk aversion trades yesterday, buying JPY and CHF across the board and selling the USD. A number of new stories of hedge fund defaults and redemption crises are intensifying the atmosphere of fear. With less oversight than other areas of the finance world, the status of hedge funds broadly is a blind spot that justifiably concerns the market. After all, if a whale or two of a hedge fund is forced to dissolve in the manner of Carlyle Capital, the pressures on already illiquid markets due to the need to unwind positions could continue to drive the already spiking volatility to further extremes on fears of a systemic crisis.

If we look at the rate differentials once again, we see the market pricing back in the 75 bp cut for the upcoming Fed meeting and the 2-year rate differentials reaching new highs in favor of the Euro. Trichet was out grumbling about the Euro again yesterday, but Mr. Vigilance will need to cut 50 bps if he wants and quick response from the market - and there are no signs that he is ready to cave on rates.

Looking at the JPY crosses, it is clear that the 100.00 barrier will give way here after, but the pressure on the non-USD JPY crosses may soon be felt even more intensely if the recoupling theme ever re-enters the picture.

Yesterday's budget statement from UK Chancellor Darling saw less reaction in the market than we anticipated due to the overriding focus on risk. As suspected, the "non-dom" related taxation proposals announced by the chancellor were heavily watered down from their originally proposed versions, which should be considered a GBP-positive development. The chancellor also announced a lower of growth forecasts, but the market has zero faith in the treasury's economic forecasting abilities. GBP failed to respond to the good news, however, as it tends to default to the weak side as long as the EUR is strong and especially when the risk aversion trade is on.

The Australian employment data showed another strong surge in employment and fall in the unemployment rate to a record low for the modern era. In terms of the economic cycle, however, employment is a lagging indicator. If we look at how the market views the Australian growth prospects, we see that Australian 2-year rates have been coming off heavily of late and the Australian yield curve is steepening. This means the market is anticipating a softer economy in the fairly near future despite a batch of recent good news. The spread of Australian 2-year to US 2-year yields shows that this spread topped out at the end of February and has declined since then save for a recent small uptick. A continuation of this development could mean that a top is in for AUDUSD. A similar look at AUDJPY rate spreads suggests that significant further downside is the risk for that pair.

Focus will be on the US Retail Sales report today, but it seems that swirling rumors and "surprise headline risks" related to any new skeletons in credit closet could predominate at any time. Volatility will make the trading environment difficult. Note that despite all the focus on the weak USD, the CAD can't seem to hold any rallies against even the greenback. Still, we'd like to see that 0.9980/1.0000 resistance give way before calling a further rally.

Technical focus: EURJPY and AUDUSD

EURJPY

Recently we posted a EURJPY in chart in which we were looking for a sizeable follow through lower for the pair on the risk aversion theme. The sell-off was alas quickly aborted as the risk aversion them came into play -note, however, that EURJPY was unable to close above the key 5-day SMA. All in all, as long as the atmosphere of fear reigns, we would expect the JPY to strongly outperform EUR. A possible retest of the 150.00 area may await here soon. Have a look at AUDJPY and NZDJPY as possible alternatives to this trade.

AUDUSD

AUDUSD topped out right at the 0.764 Fibonacci, which many favor employing as a retracement level when looking for a market turnaround. As mentioned above, the relative yield curve developments are beginning to favor the USD relative to AUD. There is little technical confirmation that a new sell-off wave could develop other than the rejection of the rally at the Fibonacci level, but continued risk aversion here could continue to see more pressure on AUD with its tendency to perform poorly when equity markets are tumbling.