Knee-jerk reaction to Fed saw USD and JPY stronger - will we see follow through on this in coming days?

Moves overnight confuse the situation with lots of new noise about the potential for alternative measures by the Fed.

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

US Fed cut the fed funds rate 25 bp to bring the rate to 4.25%. The discount rate was also cut 25 bps. The FOMC voted 9-1 on the decision, with the lone dissenter voting for a 50 bp cut.

Australia Dec. Westpac Consumer Confidence rose 1.8% vs. a drop of -4.2% in Nov.

Japan Nov. CGPI rose 0.2% vs. 0.1% expected

Japan Oct. Current Account was +¥2565B vs. +¥2277B expected

China Nov. Retail Sales were up 18.8% YoY vs. 18.0% expected

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THEMES TO WATCH – UPCOMING SESSION

Key event risks today (all times GMT):

UK Nov. Claimant Count Rate, Jobless Claims Change and Avg Earnings (0930)
EU Oct. Industrial Production (1000)
Norway Norges Bank announces deposit rates (1300)
US Oct. Trade Balance (1330)
Canada Oct. International Trade (1330)
Norway Norges Bank's Bergo speaks on rates (1345)
US Weekly Crude Oil and product inventory data (1530)
New Zealand Oct. Retail Sales (2145)
New Zealand Nov. Business PMI (2300)
Australia Dec. Consumer Inflation Expectation (2330)
UK RICS House Price Balance (0001)
Australia Nov. Employment Change and Unemployment Rate (0030)
Market Comments

The Fed's decision yesterday was per definition hawkish, as the minority view that the Fed might cut 50 bps needed to be priced out of the market when they only went 25 bps. Even more surprising to many was the lack of Fed action on the discount rate, as the 2 x 25 bp funds/discount cuts saw US equity markets throw a tantrum and plummnet over 2% into the close yesterday (many were looking for the fed funds/discount spread to narrow). Articles abound this morning complaining that the Fed is behind the curve on the discount window issue. But apparently the Fed can employ various other tools to attempt to ease the credit crunch, and the FT and WSJ and others speculate that announcement of such measures could be made as early as today - this could explain the bounce we have seen overnight after the initial reaction. Watch market reactions very closely if there is any follow up announcement on such measures from the Fed.

Less hawkish was the Fed's actual monetary policy statement, where the committee tilted toward more dovish rhetoric and makes the next rate cut virtually assured in January. The language about the growth/inflation risks being "roughly balanced" was dropped and instead the statement focused a bit more on the downside risks of growth. Still, the Fed kept some of the inflation language and still seems to be struggling with how to assess the unusual market conditions as reflected in statement "recent developments, including the deterioration in financial market conditions, have increased the uncertainy surrounding the outlook for economic growth and inflation". I guess that is Fedspeak for "We are flying blind!".

Immediate reactions in the market were a classic re-engagement of the risk aversion trade, as treasuries spiked higher, stocks sold off, and JPY and CHF rose while AUD and GBP fell. (EURCHF over the last couple of days was a classic short squeeze into "the big event" of the Fed followed by a reversal once the big event was out of the way.)  The more hawkish than expected Fed actions saw the USD index come back from new lows for the week, but the move is not yet decisive (see EURUSD chart below, for example)

The relatively large bounce overnight after the big post-Fed announcement reaction suggests that the possible move back into the risk aversion trade won't be an easy one and could be rather treacherous. Consider EURJPY, which plummeted 300 pips yesterday from the highs, only to rise well over 100 pips from the lows as of this writing. We'll need a day or two to gauge whether the reversal here is decisive and can hold across the board in the JPY crosses and in the likes of EURCHF. Still, the preferred outlook until proven otherwise is for continuation of strength in CHF and JPY.

Plenty of focus on NOK today, as the Norges bank is set to announce rates. The market is leaning for a 25 bp hike (something like 60/40 odds in favor) that would bring the rate up to 5.25%, which puts rates well in favor of the NOK over the EUR. With fairly split expectaions on the announcementt, a sharp move is almost guaranteed in the NOK crosses today.  After the Norges Bank adjusted their forward trajectory (rate expectations, inflation expectations, and growth expectations) lower last time around, it would be a bit of a surprise to see any hawkish forward guidance, and even a rate hike today is perhaps less probable than the market is pricing at present (after all, the US, UK and Canada are all cutting - does Norway want to stick its neck out this far?). Will be interesting, in any case...See the chart for technical details.

Watch for the UK RICS house price balance data out tonight (yes - it is actually released 1 minute past midnight, don't ask us why) as this is the best and most forward indicator of the trajectory of the UK housing market, as we have discussed in the past. It looks like GBP may have seen a key reversal yesterday vs. EUR and CHF and this number could help confirm or deny that development.

Charts: EURUSD and EURNOK

EURUSD saw a bearish engulfing pattern yesterday as the new highs were rejected. But the follow up lower has so far not occurred - in fact the bounce has been very large, so we're still looking at a very uncertain chart here. We look at the 1.4750 "shoulder" area and yesterday's 1.4640 lows as the key short-term triggers.

EURNOK saw a huge rally in November on the Norges Bank forecast changes and the large correction in oil prices before the recent sell-off, which has found support at the 200-day SMA around the 7.9750 area. Today's announcment could trigger a big move through support or a renewal of the rally, depending on the outcome.