It was a very long day for the bulls, as the growling risk bears finally took out a big enough bite to really bring risk to its knees today. The toxic combination of Euro uncertainty and a vicious Chinese real estate credit crackdown (a new higher reserve requirement, but also strict new measures in Beijing restricting the number of homes an investor may own) , with the background uncertainty of US financial reform was a lot for the market to wrap its head around, and FX responded with a tremendous sell-off in the market's former darlings - NZD, CAD, and especially AUD, all of which were as weak or weaker than the very weak Euro by the end of the session - and that despite the renewed blowout in sovereign debt spreads at the EuroZone periphery.
Elsewhere, the Euro worries allowed EURGBP to try below the key 0.8600 level and the stronger greenback had EURUSD trying below 1.3000 at its weakest levels on the day. The JPY was the only G-10 currency outpacing even the greenback in today's trading. Euro sentiment, already in the cellar, has turned even worse than we thought was possible as talk is surfacing of the potential for the ECB needing to monetize debt to stem the risk of worsening contagion.
Chart: Saxo Bank Carry Trade Model
We noted some divergence recently in the degree to which carry trades were recovering relative to other risk measures, which saw a less ebullient jump after the onset of the recent worries. According to our model, the carry trades have not yet responded as much as one would expect considering the behavior of our survey of other risk indicators. Note that the fast Carry Trade Index is at its lowest level since the early February trough in equity markets, and yet JPY crosses have barely turned around so far. Are carry trades diverging or are they just slow to process what is going on in the world around them? Carry traders beware if this situation continues to cause stress in risk markets in the days ahead. We could see a spectacular finish to the week when Japan arrives for work again on Thursday.
We noted some divergence recently in the degree to which carry trades were recovering relative to other risk measures, which saw a less ebullient jump after the onset of the recent worries. According to our model, the carry trades have not yet responded as much as one would expect considering the behavior of our survey of other risk indicators. Note that the fast Carry Trade Index is at its lowest level since the early February trough in equity markets, and yet JPY crosses have barely turned around so far. Are carry trades diverging or are they just slow to process what is going on in the world around them? Carry traders beware if this situation continues to cause stress in risk markets in the days ahead. We could see a spectacular finish to the week when Japan arrives for work again on Thursday.
Scared Scandies
A side note on today's action: the Scandies were flat against the pathetic Euro today - so USD/SEK and USD/NOK could be in for a rocket ride higher along with other risk sensitive dollar pairs if this move in risk aversion deepens. USD/NOK could be especially interesting tomorrow if Norges Bank is sufficiently concerned here that it doesn't hike tomorrow (fairly high odds of that since before the latest blowback analysts have been split on whether the bank would move higher this time around. Oil was down $3.50/barrel in today's trade. SEK is very leveraged to Euro demand considering its export economy.
A side note on today's action: the Scandies were flat against the pathetic Euro today - so USD/SEK and USD/NOK could be in for a rocket ride higher along with other risk sensitive dollar pairs if this move in risk aversion deepens. USD/NOK could be especially interesting tomorrow if Norges Bank is sufficiently concerned here that it doesn't hike tomorrow (fairly high odds of that since before the latest blowback analysts have been split on whether the bank would move higher this time around. Oil was down $3.50/barrel in today's trade. SEK is very leveraged to Euro demand considering its export economy.
Looking ahead
The focus in the coming days is the ECB and how it and Euro politicians respond to the situation here. Will the ECB cut the rate 50 bps and hint at new measures to get ahead of the curve by the weekend? This kind of response is likely on the table at the moment in discussions by the European powers that be. The situation is so fluid that they will need to do so if they want to brake current developments. This reminds us of the Fed back in the days of the financial crisis, when it was trying to get ahead of the situation in late 2008 and early 2009.
The focus in the coming days is the ECB and how it and Euro politicians respond to the situation here. Will the ECB cut the rate 50 bps and hint at new measures to get ahead of the curve by the weekend? This kind of response is likely on the table at the moment in discussions by the European powers that be. The situation is so fluid that they will need to do so if they want to brake current developments. This reminds us of the Fed back in the days of the financial crisis, when it was trying to get ahead of the situation in late 2008 and early 2009.
The question will be how enthusiastically the market will respond to any vigorous new program that would allow the ECB new powers, even if Dutch, German, and French politicians are willing to grant these new powers. This is a huge test for the entire ECB/Euro system and talk is already surfacing among serious analysts (BNP Paribas for one) that the larger EuroZone countries are more likely to want to exit than the countries at the periphery (see this article for more). While all of this is transpiring, how much faith will the market puts in the recovery prospects for the rest of the world while Europe struggles through its crisis? Seems to us there is enough reason for significant pause here globally, especially with uncertainty over China thrown into the equation. The EuroZone issue is similar to the US subprime in 2007-08, if perhaps less concentrated.
An excellent test for how much "the fundamentals" matter for the moment comes with tomorrow's ISM Non-manufacturing data point and then the US employment report on Friday. In the meantime, we have US weekly ABC Consumer Confidence out after the close, the Australia Apr. AiG Performance of Services Index and Mar. Building Approvals out in Asia. Tomorrow we also have the Norges Bank meeting (a bit more than half were expecting a hike before today according to a Bloomberg survey). We also have the ADP employment change number, which was way off the NFP release last month.
Exercise extreme caution as you stay very careful out there.
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