Panic Selling in Forex Begs Coordinated Easing

TODAY'S BIGGEST PERCENTAGE MOVERS

• AUD/JPY (-825 pips or -10.10%)
• NZD/JPY (-515 pips or -7.40%)
• AUD/USD (-545 pips or -7.00%)

THE STORIES IN THE CURRENCY MARKET

• USD: PANIC SELLING IN FOREX BEGS COORDINATED EASING
• EUR: BREAKS 1.35 DESPITE GERMAN GUARANTEES
• GBP: HITS 2 YEAR LOWS
• JPY: HITS 100, COULD THE BANK OF JAPAN INTERVENE?
• CAD: OIL PRICES DROP BELOW $90, IVEY PMI BETTER THAN EXPECTED
• AUD: AUSTRALIA EXPECTED TO CUT 50BP
• NZD: FALLS MORE THAN 4 PERCENT

EXPECTATIONS FOR UPCOMING FED MEETINGS

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** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE

PANIC SELLING IN FOREX BEGS COORDINATED EASING

It has been an extremely volatile day in the currency markets with big figures (100 pip) moves in USD/JPY happening in a blink of an eye. The more than 4 percent decline in USD/JPY is the largest single day percentage drop in close to 10 years. The degree of the moves that we have seen today in many currency pairs is normally something we would see in a quarter or even in some cases, a year. For example, the AUD/USD plunged as much as 9 percent today while NZD/JPY dropped more than 10 percent. Given that the dollar has collapsed against the Yen but soared against the Australian dollar, Euro and British pound this indicates that the story today is deleveraging and liquidation. With the Dow accelerating its decline on the break of 10,000, the only thing that can stop the fall in equities and carry trades is coordinated easing by the G7.

Fractured Responses Not Working - Time for Coordinated Easing

As we have seen by the US' Troubled Asset Relief Program (TARP) and the deposit guarantees announced across Europe, fractured responses are not working. There is no doubt that the problems have gone global and as result, a global response is necessary in order to stop the freefall that we are seeing in the financial markets. Over the past 20 years, shifts in the stance on currencies by the Group of Seven have triggered dramatic turns in the US dollar. Although the volatility in the US dollar has become a secondary story to the weakness in the US stock market, what the G7 meetings teach us is that a coordinated message by the major central banks around the world can stop the hemorrhaging. G7 Finance Ministers are getting together on Friday in Washington. At this stage of the game, there is no reason for central banks not to seriously consider coordinated action. The European Central Bank hinted that they are ready to cut interest rates, the Bank of England and the Reserve Bank of Australia are expected to do so this week and Fed fund futures are pricing in a greater chance of a 75bp versus 50bp rate cut by the end of the month. It is time for the Bernanke to step up to the plate and do all that he can to stabilize the financial markets. Increasing the size of the Treasury Auction Facility and paying interest on reserves are just not enough.

Expect a Dead Cat Bounce

For both carry trades and equities, the sell-off has been nothing short of brutal. However as we have on September 30th, the day after the Dow Jones Industrial Average closed down 777 points, a dead cat bounce of a few hundred points would be natural. We have been calling for the Dow to hit 10,000 and for USD/JPY to fall to 100 for a good number of months and now that those targets have been reached, there is a decent chance that could see a bounce. Wall Street and Main Street have been frightened by the monumental moves in the stock market and when fear is at its peak, the light may be just around the corner. This is not to say that we believe that rosier times are ahead, but the hemorrhaging may soon ease. The crisis in the financial markets has become so severe that a reaction that is more significant than what we have seen so far needs to come from government officials and once there is coordinated action, we may finally see stability. Growth will remain weak however, but for the US stock market we could enter a range trading phase. After Black Monday in 1987, the Dow Jones Industrial Average range traded for 14 months.

Zero Percent Interest Rates in the US?

Given that the Japanese went to zero percent interest rates in order to pull their economy out of stagnation, one of the big questions in the markets is whether the US will do the same. Although we do not expect interest rates to fall to zero percent, current conditions in the US economy and the US financial markets are bad enough to warrant bringing interest rates back down to the 1 percent levels that we saw during Greenspan's tenure. The financial crisis that we are facing now is certainly damaging than the burst of the technology bubble. The minimum that Bernanke needs to do is to bring interest rates down to 1.50 percent. The sell-off in commodity prices also helps to offsets the inflationary pressures of printing money, making it more feasible for the Federal Reserve to cut interest rates. For the US, lower interest rates will mean a lower currency. When Greenspan cut rates from 6.5 percent down to 1 percent, USD/JPY fell from a high of 135 to a low of 103.40. This 25 percent move represented the dollar's shift to a funding currency. Since the Fed started cutting interest rates last August, USD/JPY is down 18 percent. If 1.00 percent becomes a reality in the US, USD/JPY could hit 95.

The minutes from the Federal Reserve's monetary policy meeting in September is due for release on Tuesday. The market will be looking to the release for any clues on possible easing.

EURO BREAKS 1.35 DESPITE GERMAN GUARANTEES

In an attempt to avert panic, the German government announced that they would guarantee all bank deposits and have put together a second bailout package for Hypo Real Estate, one of the Eurozone's largest commercial property lenders. Unfortunately Germany's announcement did nothing to stem the decline in the EUR/USD which broke 1.35 level to hit a low of 1.3444 intraday. The sell-off in the EUR/USD is a direct result of EUR/JPY weakness. The announcement by the German government should have been positive for the Euro but larger macro factors were at play. It is realistic for the EUR/USD to continue to fall even though the problems in the US have not been resolved. As usual, the reason for this is interest rates. Since last August, the Federal Reserve has cut interest rates by 325bp and in that time the European Central Bank actually raised interest rates by 25bp. Therefore not only does the ECB have more room to cut interest rates, but they may find themselves cutting interest rates well after the Federal Reserve puts an end to its easing cycle. We continue to believe that the EUR/USD has more room to fall especially since its fair value is not until 1.15. German factory orders are due for release tomorrow. Given the slowdown in the global economy and the drop in the manufacturing PMI index, factory orders are expected to be weak.

RESERVE BANK OF AUSTRALIA TO CUT 50BP

The worst performing currency today was the Australian dollar. It fell 6.7 percent against the US dollar and 9.8 percent against the Japanese Yen (800 pips). Risk aversion, carry trade liquidation and the prospect of a 50bp interest rate cut by the Reserve Bank of Australia drove the currency to a 14 month low against the US dollar and a 5 year low against the Yen. Next to the Reserve Bank of New Zealand, who surprised the markets with a 50bp interest rate cut last month, the central bank of Australia has been the most aggressive in using monetary policy to combat slowing growth. The key this evening will be the comments from central bank governor Stevens. If he hints of more rate cuts to come, we can expect further weakness in the Australian dollar. If he indicates that 50bp is all they need to ease, there could be a relief rally in the Aussie. Meanwhile the New Zealand and Canadian dollars have also sold off aggressively despite a stronger IVEY PMI report from Canada. Falling oil prices have offset the better than expected economic data.

BRITISH POUND HITS 2 YEAR LOWS

The sheer liquidation of carry trades and the aversion form high-yielding currencies has led to an across the board fall in the British pound. GBP/JPY alone shed more than 1200 pips today, further dragging down GBP/USD which hit a 2 year low. Like the German government, the UK government raised their deposit insurance from GBP 35k to GBP 50k. Unfortunately, as we have seen in the US and Germany, the increased bank deposits have failed to bolster confidence. Much attention will be focused on Thursday's Bank of England rate decision. Although the market is looking for only a 25bp rate cut, there is a small chance that the BoE will cut by 50bp if they want to start being proactive rather than reactive. The only reason British policy makers have been hesitant to cut rates is that consumer prices have rapidly increased from 2.2% in January 2008, to 4.7% in August. If inflation was not a problem, and it is becoming increasingly less so, UK interest rates would probably be at 3.50 percent right now. Industrial Production numbers will be released tomorrow. Given the macroeconomic environment, the production numbers are likely to be worse than the -2.0% forecast.

USDJPY HITS 100, COULD THE BANK OF JAPAN INTERVENE?

A massive selling has hit the Japanese Yen crosses, driving USD/JPY below 100. This rapid ascent in the Yen has many traders wondering whether there could be Bank of Japan intervention. As an export dependent nation, a strong currency is not in Japan's best interest. However unlike in the past where the BoJ has intervened when USD/JPY fell below 105 and 100, we may not see any action by the Japanese government this time around. Since the problems are inherent in the US and the Eurozone, intervening at this time may be counterproductive for the Japanese. The Japanese government needs to stand aside and allow the US and Eurozone governments to take their measures to spur growth and not strengthen the dollar for their own short term relief.

GBP/USD: Currency Pair in Play Over the Next 24 Hours

With Industrial Production numbers being released tomorrow at 4:30 am ET or 8:30 GMT, GBP/USD will be the currency in play for the next 24 hours. It is largely expected that because of the global economic environment the release will spell more bad news for the troubled pound.

Technically, GBP/USD has entered the sell zone which is determined with the use of Bollinger Bands. It has fully corrected the retracement that took place from September 11th to September 23rd. The 1.7456 level is fairly decent support since it was the low set in early September, but given that the currency pair is in the sell-zone, we are looking for an opportunity to sell on rallies than buy on dips. The downtrend would be negated by a move back up to 1.7650, which is where the 23.6% retracement meets the one standard deviation Bollinger band, and 1.7843, where a previous high meets the 38.2% retracement of the August to October sell-off.

Kathy Lien
http://www.gftforex.com

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