Risk aversion theme may continue in FX on weak equity markets. JPY may continue recent strength

Will AUD weaken this week despite expected rate hike? AUD/JPY could be a big mover if risk aversion deepens.

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• Citigroup's CEO resigns as it is revealed that the bank may have to write off up to $11B 
• JPY strenghthened slightly at BoJ press conference, in which Fukui said keeping rates too low is "risky".

THEMES TO WATCH – UPCOMING SESSION

Key event risks today (all times GMT):

• UK Services PMI (0930)
• UK Industrial/Manufacturing Production (0930)
• US ISM Non-manufacturing (1500)

Market Comments

The USD is unchanged from Friday's pre-payrolls levels as conflicting themes have the greenback struggling for direction. We contemplated the impact of negative data on Friday, but the data turned out unexpectedly positive, so our outlined scenario didnt get any playtime. The USD weakened despite the good data as, ironically, good news for the US means that global equity markets may not need to worry so much about a US slowdown, and as long as that is the case, the global risk party (which tends to favor the USD weaker on the decoupling theme) can continue. This reaction pattern could continue in the short term. Meanwhile, further horrific news from the big banks Friday and over the weekend has quickly clouded any picture one tries to form from economic data.

First, the SEC announcement of an investigation of Merrill's accounting practices and attempts to park losses in hedge funds has tremendous implications that shady dealings will continue to be revealed for some time. Then the news of the Citigroup CEO resignation and potential $11B writedown have stocks struggling once again for support overnight and is keeping the risk aversion fires burning as these developments certainly trumped the relevance of the US employment report. Risk spreads are showing a lot of worry out there, and EM currencies are finally starting to show signs of a bit of softness, as the should considering the recent widening spreads between EM bonds and US treasuries. Will this keep the USD from weakening further for the short term? Hardly any technical signs of this so far, but any EM weakness could at least partially brake the pace of further USD declines.

Additionally, the BoJ's Fukui was out this morning talking perhaps a bit tougher than normal, but we suspect that the JPY is responding more to the risk appetite picture rather than the slightly more hawkish talk.

Still, we outlined a trio of potential risk aversion trades on Friday, and these have yet to follow through in the direction expected if the risk aversion theme is to continue. In USD/CAD's case, the tremendously strong Canadian employment data and continued support in energy prices took the pair to impressive new lows, as CAD managed to avoid any risk contagion for now. The jury is still out on the JPY crosses and EURCHF - but traders should expect these to fall sharply if the present risk averse environment keeps up is head of steam.

This week, we highlight AUD as the RBA is expected to hike rates to. AUD has been riding the strength in commodities prices and the most hawkish rate expectations of the G7 currencies. While these factors favor the Aussie, we must also chalk up a couple of worrying developments. First, copper prices, a good indicator of the non-precious metal market are trading at close to two-month lows, even if Gold has achieved impressive new levels. Also, AUD tends to perform best in a risk willing environment - the opposite of what we are seeing at this moment. Could this week see a big correction in AUD crosses, even if RBA does hike as expected? AUD/JPY is perhaps the most direct way to play this idea.

We also have a look at GBP/CHF today. GBP has been supported by the BOE's unwillingness to let the market dictate its next move (market priced in cuts in the wake of the Aug credit crunch and then was forced to unwind these expectations as BOE rhetoric offered no support for this thesis) and by the fact that the British banks have given up seeking any liquidity from the tight BOE and are instead seeking it from the ready and willing ECB in Frankfurt. This has resulted in an interesting struggle in GBP/CHF around the 55-day and 200-day moving averages.

Charts: AUDJPY and GBPCHF

AUDJPY recently suffered a strong rejection of the new highs attempted above the 107.00 level. If flatline support at 104.30 gives way, the way to the 0.618 Fibo retracement level at 102.60 area may open - an interesting rising trendline comes in not far below that level.

GBPCHF - which way? This pair has really struggled to find direction. Bulls still need for the 2.4200 area to give way to find further optimism, as this is both flatline resistance and the approximate 200-day MA. The bears need a move back through 2.3800 flatline support, though a break of the rising consolidation line shown in blue would be a start to more bearish potential.

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.