Sunday, May 11, 2008

Massive Bank Losses And Write Downs Drag Risk Appetite And Carry Lower

The high end of the yield curve has taken a significant hit over the past week; and carry trades have suffered the consequences. The DailyFX Carry Trade Index sunk $298 dollars since last Friday after failing to over take a descending trendline that has been directing the basket since risk appetite was tripped up by the subprime meltdown last summer. In turn, a breakdown in USDJPY and other yen crosses has weighed on risk reversals, which show a greater demand for puts. However, during this reversal, the outlook for a BoJ hike over the coming year has eased and volatility cooled, suggesting this will be a more orderly (and perhaps short-lived) carry unwind.

US Dollar Consolidates As Oil Tops $126

The US dollar was mixed as raging oil prices above $126/bbl pressed on investors, but led the Canadian dollar to pick up the biggest gains. The Australian and New Zealand dollar however, depreciated the most against the US dollar, sparked by a rise in risk aversion. On the other side of the spectrum, the low yielding Swiss franc and Yen continued to climb against the greenback as the pairs traded at 1.041 and 102.9, respectively. Mixed sentiment for the European currencies sway the British pound to inch lower to 1.952, while the Euro picked up to trade in the 1.548 range.

On the economic front, the Canadian Net Change in Employment index held up for the fourth consecutive month as it rose to 19.2K from 14.6K, with the International Merchandise Trade index adding to the mix as the surplus widened to C$5.5M from C$4.8M due to a surge in energy exports. Looking at the US, the trade deficit narrowed to $-58.2B from $-62.3B as imports declined to a six year low, but did not help the US dollar as exports dipped for the first time is seven years.

The stock markets landed in troubled waters as AIG posted a $7.8B loss, with Citigroup heightening bearish sentiment as they plan to sell $500B in assets. As a result, the DJIA fell 120.90 points to 12,745.88 points, with 24 of the 30 components declining. The broader S&P500 dipped 9.40 points to hold off at 1,388.28 points, with 208 stocks falling to a new 52 week low.

Increased volatility in the stock markets has improved the appeal of US Treasuries, and spurred demands for long-term bonds as the financial markets continue to face downside risks. As a result, the benchmark 10-Year yield fell to 3.775 percent from 3.782, while the 2-Year yield rose to 2.247 percent from 2.227 percent.

Looking ahead, we expect limited event risk for the US dollar on Monday as the Monthly Budget Statement is the only scheduled release for the US, but expect to see increased volatility in the British pound as the Producer Price Index and the Trade report is due out for release at 8:30 GMT.

Japanese Yen Pairs Primed for Volatility, JPY May Gain Further

Implied volatility is one of the most tried and true methods for objectively measuring expected volatility in the spot market. Derived from currency options with different maturities, implied volatilities are used to help predict potential movements in the spot market and is one of the most popular strategies of systems traders and other professional hedge funds.

At its most fundamental, the basic and intuitive interpretation of this implied data is often the most telling for traders. Taken alone, a steady rise in the longer-term implied volatility (the red line) is indicative of a strengthening trend; while inversely, a decline often reveals that a period of range or consolidation in spot is ahead or already in place. Additionally, the histogram or spread between the shorter and longer-term implied volatilities (the blue colored bars) tells a different perspective. As the histogram rises, volatility is expected to pick up faster in the near future relative to the longer-term range. Ultimately, this increases the probability of a breakout scenario in the underlying currency.

Forex Video - USD/CAD Tumbles, How Will Inflation and GDP Numbers Impact Currencies Next Week?

Written by Terri Belkas and John Kicklighter, Currency Analysts

· Canadian employment data beats expectations, leads to Loonie rally.
· Heavy event risk looms next week - which indicators do you need to watch?

Stories to watch on DailyFX

· Heavy event risk looms next week - will Tuesday's US Retail Sales report be surprisingly strong?
· USD/CAD fell on Friday, but is the Canadian dollar ready to fall across the board?

US Dollar: US Retail Sales Could Get A Surprise Boost on Tuesday - Why?

Advance Retail Sales are expected to fall back 0.2 percent after showing a surprising 0.2 percent gain during the month prior, but given the current economic scenario, this figure could prove to be even more disappointing when announced at 8:30 EDT.

What Are The Markets Facing?

Advance Retail Sales are expected to fall back 0.2 percent after showing a surprising 0.2 percent gain during the month prior, but given the current economic scenario, this figure could prove to be even more disappointing when announced at 8:30 EDT. Indeed, consumer confidence is rapidly deteriorating and energy prices continue to skyrocket. During the month of April, the University of Michigan consumer confidence survey plunged to a 26-year low of 62.6 while the Conference Board’s measure dipped down to a 5-year low of 62.3 on a gloomy combination of jittery financial markets, a collapsing housing sector, and oil rocketing to record highs. There is little doubt that retailers are contending with difficult circumstances as they are forced to offer the biggest discounts possible in order to draw customers, which will negatively impact profit margins. However, there is potential for the Advance Retail Sales index to actually show a positive increase as the result of prices, namely, sales at fuel stations. Indeed, this index is not adjusted for inflation and average gas prices rose above $3.50/gallon during the month and have only continued to rise.

Bonds – 10-Year Treasury Note Futures

A daily chart of Treasuries highlights the break above trendline resistance and the subsequent advance toward resistance at the confluence of the 100 SMA and 38.2 percent fib at 116-20. While we are likely to see a test of this resistance level on Monday, Tuesday’s release of US Advance Retail Sales provides significant event risk for the contract. Indeed, retail sales are forecasted to slump, which could support the case for additional Treasury gains. On the other hand, if rocketing gas prices lead the headline retail sales index to deceptively rise, the contract could pull back toward support near 115.

Tuesday, May 6, 2008

Yen Crosses: Corrections Continue but Larger Trend Still Down

The choppy decline since the October high at 91.42 may be a series of 1st and 2nd waves. Under this count, the NZDJPY needs to remain below 88.11 for a C wave decline that will eventually come under 74.25 to remain on track. An alternate count treats the entire drop from 91.42 is an ending diagonal (similar to the EURJPY). Under this alternate, a wave 2 correction is underway towards fibo resistance in the 84/85.80 area. A rally through 88.11 would make this the preferred count. In both cases, lower prices are expected. The outcome would be delayed under the alternate count.

CHFJPY Range Bound Following Break in Bullish Trend

Trading Tip – A common cliché among traders holds that “the trend is your friend.” When applied to range trading through periods of consolidation in an otherwise trending market, this means only entering a trade in the direction of the trend. In particular, we will opt not to buy CHFJPY even though the pair is trading close to the bottom of the range because the direction of the recent breakout was to the downside. We would rather miss out on a trade and lose nothing than get long counter-trend if CHFJPY simply sinks lower from here without oscillating to the 50% Fib.

Note – Today’s market environment is not conducive to a range-bound approach with most pairs trending. Finding a range trading opportunity often means relying on exotic crosses and thereby contending with higher volatility levels. Conservative traders that are intent on following a range-bound approach should be mindful of this when evaluating these trade ideas.

Event Risk for Switzerland and Japan

Switzerland – With Consumer Price Index figures out of the way, the Swiss calendar has become substantially lighter for the rest of the week. The only remaining item on the docket is Thursday’s jobs report. Expectations are for the rate to remain at a consistent 2.5%. Traders will be wary of this ticking higher as the Euro zone exports the effects of the US malaise to the mountain nation.

Japan –Friday’s release of the preliminary estimate of the Leading Economic Index for March is the only substantial release from Japan this week. Expectations are for a sharp decline as the Japanese economy suffers high oil prices and the loss of vigor in the US export market.