Market focuses on Bernanke's expectations of poor US Q4 growth and keeps USD on the defensive

In the carry trade department, CHF and JPY diverge, as resilient non-US equities keep JPY from moving decisively stronger.

MAJOR HEADLINES – PREVIOUS SESSION

Overnight developments:

• New Zealand October Home Sales fell -22.6% YoY vs. a -31.9% drop in Sep.
• US Treasury Secretary Paulson accused China of being "out of step" on its exchange rate policy.

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

• Norway Oct CPI and Producer Prices (0900)
• UK Sep Visible Trade Balance (0930)
• US Sep Trade Balance (1330)
• Canada Sep International Merchandise Trade (1330)
• US University of Michigan Confidence (1500)

Market Comments

The combined rhetoric of Trichet and Bernanke offered few surprises yesterday, and after a period of indecision, the weaker USD trend was reinvigorated overnight, partially on additional credit worries. While Bernanke's testimony reflected a relatively balanced set of concerns (inflation, USD, growth) and the observation that the US economy is "resilient", his clear expectations of an ugly growth number in Q4 leave a majority expecting a 25 bp cut at the December meeting. This was somewhat dovish after other Fed officials recently sounded a bit more hawkish - there is clearly a heated debate going on within the Fed, though we won't see more on this until the 20th of Nov release of the FOMC minutes. Trichet's speech showed the highest level of concern on the Euro strength since the late 2004 episode, as he dusted off the "brutal moves are unwelcome" phrase again yesterday. So ECB monetary policy is clearly handcuffed by the EUR strength, even as it talks up inflation concerns.

The BOE decided to leave rates unchanged once again, but we still like the weaker GBP story - even as yesterday's no-go put a lid on EURGBP. Next week could prove pivotal with a flurry of inflation data and the BOE inflation report as well sas the RICS housing data and Retail Sales. A Friday 16 Nov EURGBP call option, strike 0.7000 costs 16 pips as this is being written.

We mentioned yesterday that carry trades could see additional pressure, but the normally slavish positive correlation of CHF and JPY began to diverge sharply yesterday as CHF really followed through and the JPY is still "iffy". On the one hand, it is clear that Swiss fundamentals of late have been far healthier than the news emanating from Japan, but the two currencies have tended to trade on the same footing regardless. Perhaps the idea has emerged over the last few days that Europe suffers more with a strong currency than does Switzerland (where the central bank governor has been very vocal on the CHF weakness versus EUR), and the market may be switching to USDCHF as it becomes the more popular trade. After all, with USDCHF, you have a compliant central bank and a risk aversion trade all in one. The pair has just broken below the 2004 lows at 1.1290, and only the 1995 low at around 1.1115 is holding it back from an all time low now. Still, the JPY could easily more than catch CHF on any real global panic in asset prices, which has yet to materialize.

One interesting "bigger perspective" note on the Japanese economic situation that deserves consideration. An article in the WSJ this morning describes how growth is even weaker than otherwise would be expected due to new housing safety regulations that have remarkably disrupted the Japanese housing construction industry since June. This makes the stark drop in housing starts (YoY drops to the tune of 20 to 40%+ after relatively stable numbers previously) a severe drag on growth now, but will inevitably add to activity on pent-up demand further out. Still, JPY will continue to trade on risk aversion, which has heated up on many occasions recently, but still is yet to really follow through for the global growth/EM equity bears.

Today we have the UK, US and Canadian Trade figures. The US number could surprise to the upside. Let's see if the market cares.

Chart: AUDUSD - interesting support and resistance levels for short-term tactics. AUDUSD showed recent signs of exhaustion after initially spiking higher on the RBA decision to hike rates and further comments. So the move above the 0.9345 level couldn't hold and so far the pair has twice found support exactly at the downside swing 0.618 Fibo at 0.9218 after an initial spike through that level. If 0.9218 gives way again, the pair could follow through significantly. On the flipside. the 0.9318 level (the 0.618 Fibo for the decline from the 0.9400 - not shown here) has been poked at three times without closing above on 4-hour bars - so this is the important upside swing level, with the actual high on the consolidation coming in around 0.9330.

Note: the support/resistance levels used in the matrix’s of this document are levels derived from yesterday high, low and close. Reference in the text to other support/resistance levels will occur.