USD fails to get boost from Friday's employment report. All eyes on tomorrow's Fed decision for USD direction

Will the Fed cut 25 or 50? Will USDJPY continue higher after the technical break or will it resume the sell-off?

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• China raised bank reserve requirement ratio by 1 %, the largest such move since 2003
• Japan Oct. Machine Orders rose 3.3% YoY vs. -2.3% expected
• Australia Home Loans for Oct. fell -0.7% vs. +1.0% expected
• China's Nov. PPI rose 4.6% YoY vs. 3.5% expected
• UBS announced it will write down $10 billion in US subprime investments.

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

• Sweden Oct. Industrial Orders and Production (0830)
• Norway Nov. CPI and Nov. Producer Prices (0900) 
• UK Nov. PPI Input/Output (0930)
• Canada Nov. Housing Starts (1315)
• US Oct. Pending Home Sales (1500)
• China Nov. CPI (0200)
• Japan Nov. Consumer Confidence (0500)

Market Comments

The market was perhaps too focused the Fed rate decision this week to react to the better than expected employment report on Friday - either that or the expectations had shifted even higher than the relatively good report we saw after last Wednesday's dramatically stronger ADP report, meaning that the market may have read Friday's report as a slight disappointment. In either case, despite the report, and despite the supposedly positive reaction to the subprime bail-out plan, US rates on the short end only move marginally higher, and the reaction in the STIRs was decidedly muted. The long end saw a bigger reaction but some of the sell-off there has already been erased in overnight trading. In short, the market is still pricing in a reasonable chance (25% range) that the Fed will cut by 50 bps tomorrow evening. Others are pointing out that the Fed may cut only 25 bps, but then cut the discount rate by 50 bps. This would further reduce the spread between the two rates to 25 bps (it has historically been at 100 bps). This latter scenario looks like the higher odds scenario in light of the relatively resilient data coming out of the US of late: so far we're seeing a banking sector in an acute crisis much more than we are seeing signs of a broader economic contagion (even if we believe that the contagion eventually does spread...) and a bigger chop to the discount rate would more appropriately address the sector seeing the most pain at present while only cutting the fed funds rate by 25 bps would allow the Fed a bit of wriggle room further out if inflation remains elevated.

Interesting developments on the China front overnight, as inflation pressures are soaring in China. The tightening of the reserve requirement ratio was the largest since August, 2003. Paulson is headed to China this week to put more pressure on the Chinese to revalue. In the meantime, it looks as though Blackstone may team up with the Chinese SWF to acquire Rio Tinto, one of the world's largest mining companies (market cap over GBP 80 billion). The commentary out there on this deal makes the interesting point that such activities are so large that it could help ease the pressure on CNY to strengthen on potential outward boun capital flows. And considering the extremely weak USD, many US assets must look very attractive, whether Chinese SWF or other countries's SWF are doing the buying. This is another reason to believe that the US dollar may not weaken much further, even if the interest rate differentials aren't telling a positive story for the greenback just yet.

This may be a pivotal week for the JPY. As we pointed out last week, the major US indices are trading right at their 55-day moving averages after having fallen through them rather decisively in early November. Meanwhile, USDJPY just broke resistance in the 111.35 area while EURJPY continues to pound at the 55-day SMA - which it has been doing for nearly a month now without managing to close decisively above. If we get a further extension of the recent equity rally, riskier assets could continue to bask in the sun for a bit and the pressure on the JPY to weaken could continue in the short term. If worries of a global growth slowdown resume, however, we could see a renewal of the equity sell-off and JPY crosses (including USDJPY) could come under pressure again. Seems as if tomorrow's Fed announcment and monetary policy statement guidance may be the trigger for the one or the other scenario and therefore may be a very critical inflection point for the rest of the year.

On the economic data front, the major US data this week starts Wed. with the Oct. Trade Balance figure. Thursday sees US Nov. PPI and Retail Sales and Friday the US CPI.