Market moves are white-hot as USD soars

The reaction to the Fed’s operation twist is not at all what Bernanke and company were looking for. Meanwhile, the rest of the world isn’t looking so great at the moment either, as fresh news out of China and Europe suggests.

The Fed’s announcement of an “operation twist” that has so far failed to rouse the investing public’s confidence in any way – a remarkable deviation from past behavior. Recall that the November, 2010 announcement of QE2 was followed by a few weeks of consolidation, but that was only after a rip-roaring rally in risk assets that had taken place from the moment QE2 was hinted at. Then, after the brief consolidation, risk rallied for another several months.

This time around, we only had a range-bound equity market broadly speaking (though tech stocks were very strong lately) and the actual announcement – despite its larger than expected size and the leniency shown to banks by not announcing a lowered rate on bank reserves – saw bank stocks punched for huge losses and risk sold off everywhere. Because Operation Twist implicitly supports the short end of the curve for the USD, the combination of this and the risk-off reaction saw the USD explode stronger.

China struggling
A couple of other events are conspiring to paint a more positive picture for the USD as well – China’s HSBC flash manufacturing PMI coming in lower than expected raises further nervousness in an already near-panicky emerging market sector. And even the CNY crumbled overnight as measured by the 12-month NDF’s. On that note - is there not a strong risk to the complacent view that the CNY must strengthen from here. Remember that the yuan forwards actually weakened for a time back in 2008 before China froze the rate and top-to-bottom, the yuan weakened some 15% before resuming its uptrend against the greenback. After all, inflation and money growth in China have been under-reported, meaning there has been a de facto stealth strengthening on top of what the Chinese regime has allowed  to transpire. This realization and a reversal of “hot money flows” could reverse the trend for a time, regardless of the long term fundamentals. Another worry for China is the massively falling copper price, as copper has been employed in all manner of collateralized credit schemes and the price could suddenly see ugly problems surfacing in the weeks to come.

Europe teetering on brink of recession?
The other items of interest on the PMI calendar were the EuroZone’s preliminary September PMI readings, which saw Germany,  the manufacturing engine of Europe, perched right on the 50.0 fulcrum that divides expansion from contraction. The trend suggests that October will show contraction and the rest of the EuroZone has already been there for a couple of months now. Over in the UK, the CBI total orders trends registered a disappointing -9 while average selling prices rose to index 13 – low demand and high prices with a bank about to launch another round of QE -  but then again, the world is already endlessly short sterling, one would think and we have to consider what is already priced in.

Odds and ends
US jobless claims remained high last week and Canada had a terrible retail sales report as the data coming out of Canada has disappointed heavily of late – let’s see how the situation looks when the Canadian housing bubble moves into the phase already exhibited now in Australia, where the bubble is more mature and could soon move into full scale implosion – particularly if the BHP Billton stock price is telling us something about the prospects for the mining sector Down Under. Still, CAD appears more fairly valued than the Aussie in the big picture.

Chart: AUDUSD
Aussie was hit a bit less hard than the Kiwi overnight as New Zealand’s GDP figure disappointed, but the move was nonetheless very impressive, completely taking out the neckline area we discussed a few days ago and thus also taking out the lows for the year, save for the brief post-Japanese tsunami swoon. Targets are hard to come by when you’re in such open territory, but the next levels of interest are perhaps the 0.9400 area (early 2010 highs) and then 0.9210 (0.618 Fibo) and then sub 0.8100 (2010 low) if the S&P really picks up downside steam and posts significant new lows on the year.



Looking ahead
It’s a panicky market and above all, one should stay very careful out there – this market can go anywhere in the short term and the old law of overleveraged markets always applies – the bigger the move the higher the odds that the move will could become even bigger until proven otherwise. This could add up to a parabolic resolution in the days to come – extremely short duration, but with extremely large moves, and we need to wait for “a bounce” to see where we stand (the bounce may happen today, tomorrow or whenever). Another day or two of this and we risk another coordinated intervention effort or at least the threat of one. On that note, we’ve got G20 and IMF meetings this weekend.