Renewed credit worries have put JPY back in the drivers seat. USD getting a big boost on the risk aversion theme again

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• Barclays denies rumors of huge US subprime related losses and says it will give fuller financial disclosure on 27 November
• Japan Current Account surplus for Sep out at +2880B Yen vs 2690B Yen expected and 2081B Yen in August
• Japan Corporate Goods Price Index rose 2.4% YoY in October vs. 2.3% expected.

THEMES TO WATCH – UPCOMING SESSION

Key event risks today (all times GMT):

• Today is US Banking Holiday (fixed income futures closed, US stock exchanges open)
• Sweden Oct CPI (0830)
• UK PPI Input and Output (0930)
• UK RICS House Price Balance (00:01)

Market Comments

Credit worries accelerated suddenly again on Friday, with Barclays write-off rumors swirling and the news of a blown up CDO structure sending red flags up everywhere. This saw the broad based risk aversion trade resuming in force, with equities seeing a large sell-off to end the week on an ugly note and yields diving lower. The equity sell-off continued in Asia on Monday. In FX, the JPY grabbed the pole position, and JPY crosses are smashing down through key levels. This action could be set to continue this week.

A key development this week that will keep the focus on credit worries is a new accounting rule from the US that may require banks to announce further large writedowns due to a requirement to record prices for "Level 3" assets that are illiquid. This rule is to go into effecton Thursday, so watch for announcements up to that day.

So where are JPY crosses headed? Many of the cross/JPY pairs fell through their 55-day SMA's late last week, as the sell-off may accelerate. Like last time around in August, the daily ranges could accelerate dramatically. Choosing a pair to trade, we would look at non-USD JPY crosses (even though it is also falling here), with the likes of GBP/JPY, AUD/JPY and CAD/JPY being the big movers. Could GBP/JPY be headed for a quick meltdown to 200 in the coming weeks? Gold is off USD from its recent highs - could AUD/JPY be headed for the basement as well? If oil adjusts sharply lower this week, CAD/JPY could actually see the largest sell-off of all the G10 currencies in a strong JPY environment.

We note that the USD did very well on Friday, as the moves we are seeing in the JPY supports the USD purely from a market positioning perspective. This means that as long as we have the risk aversion trade on, the USD will likely remain reasonably bid, especially versus the "other dollars" and GBP.

The G20 is set to meet this coming weekend and the weak USD will be at the top of the agenda, according to a Canadian official. Now that USD/CAD is trading above the 0.9400 resistance level, we wonder if the pair may continue to rally toward its first Fibo level at 0.9750 before meeting resistance, or if it might even make a dash for parity if the volatility accelerates.

The weak GBP story finally kicked into gear Friday as the credit worries are particularly negative for GBP is the world's most dependent on the financial services industry. EURGBP jolted higher and is now trading at the highest level since Jan 2005 and could be set to test much higher still, especially if the data this week from the UK supports the bearish thesis.  GBP/CHF has been an even bigger mover (to the downside), as CHF had its strongest week in recent memory this last week. Going long CHF is a slightly less volatile version of going long JPY in this environment.

Looking at the economic data for the week ahead, we wonder how much it will affect the bigger picture with so much focus suddenly back on credit again, but watch for the UK inflation data today and the RICS house price balance released overnight. Other highlights include: Tuesday we get the German ZEW. Wednesday, we have the EuroZone CPI and the US PPI and Retail Sales. Thursday we get US CPI and  the Empire and Philly Fed numbers. Friday we see US Industrial Production and TICs data.

One very key development we will be watching for is a convergence of EuroZone indicators with those from the US, as we feel that if the EuroZone shows noticeable signs of slowing relatively to the US, EUR/USD could show signs of having put in a top for now.

Charts: GBP/JPY and USD/CAD

GBPJPY: closed back below the 55-week moving average last week and may be in the process of building a head and shoulders formation with the neckline on weekly closes at about 226.50. A meltdown in risk appetite could see the pair to 200 eventually.

USDCAD: is seeing a sharp countertrend correction that could extend in the current environment. A natural first target to the upside comes in at 0.9750 area, the 0.381 Fibo for the last big leg of the sell-off from above 1.0865.

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.