G7 Statement focuses on China, giving USD weakness a theoretical green light. But how long will it last?

MAJOR HEADLINES – PREVIOUS SESSION

Overnight developments:

• Australia Producer Price Index for Q3 out at 1.1% vs. 0.9% expected (QoQ) 

THEMES TO WATCH – UPCOMING SESSION

Market Comments

The G-7 produced little in the headlines. Therefore, the knee-jerk reaction to the statement, which focused on the Chinese Yuan and the unified call for China to allow its currency to strengthen more rapidly, was that this gives a green light to further USD weakness. This is understandable on the surface, and statements by the ECB's Weber over the weekend related to clear inflation concerns certainly give the impression that the ECB is very focused on it's inflation fighting mandate despite the current EURUSD levels and that their is further room for interest rate spreads to widen between the US and Europe. In our view, such statements are poorly timed and a bit disingenuous, to say the least. The major European administrations, after all,  are showing increasing unity in their discomfort with the strength of the EUR and, according to at least one article out over the weekend, a broad statement expressing worries over the USD decline would have gone through, had not US Treasury Secretary Paulson vetoed it. Also, the Bank of Canada's Dodge called the CAD's appreciation "abnormally quick" and sayed that its strength did not appear justified by fundamentals - without coming right out and saying that rampant speculation was driving the currency higher. The clear implication for CAD is that chances are nil for a rate rise in the near future. The general impression is that sharper rhetoric and even more may lie ahead if current trends continue.

Again, we must point out that the big drive of the market here is less about G-7 statements, and more about the entire risk appetite environment, and how it is being expressed in interest rates and equities. The developments Friday were a clear signal that global markets are worried about the future, with stocks pummeled for the biggest losses in some time and long interest rates taking a nosedive. European 10-year rates plummeted through their 55-day and 200-day moving averages on Friday in a clear sign that the market has serious concerns about future growth prospects, inflation notwithstanding... If these concerns spread and develop into a broad concern over economic growth potential globally, then the USD will have very limited further downside indeed within the non-JPY G-10, as the decoupling view would promptly derail and major economies would being to catch up with the US state of affairs. The UK is the leading candidate for this development.

Data-wise, the week ahead is relatively light, with some of the highlights being: Canada Retail Sales on Tuesday, Australia Consumer price data Wednesday, US Existing and New Home Sales on Wednesday and Thursday, respectively. The RBNZ also announces on Wednesday evening (Thursday in NZ). Thursday also sees the German IFO and the volatile US Durable Goods Orders. Friday Japan releases its inflation and industrial production data.

In our charts section we highlight two potential ways to play a move toward risk aversion in the days and weeks ahead.

Charts: CADJPY and NZDUSD

CADJPY In the G-10, this has been a star performer in the G-10 carry universe as the strong global growth and carry trade themes have found clear expression in this cross, as have the enormous surge in oil prices. One thing to note concerning the latter, now that we have rolled off the November contract in WTI crude, the December contract is now trading 86 dollars and change, after recent headlines touting 90 dollar oil, this looks like a hefty price drop indeed as the market is seeing steep backwardation. Dec 08 crude can be had for USD 79. The chart gets interesting if we follow through below the post g-7 kneejerk sell-off lows below 117.00, as this would begin to confirm a rejection of the new highs above the old 118.00+ top.

NZDUSD NZD and CAD are the most overvalued of the G-10 currencies, and as long as risk aversion is the order of the day, NZD could bear the brunt of this. This trade expresses the view that the USD weakness is overdone and that it may soon bottom out. In any case, the pair could drop even in a weakish USD environment as NZD will struggle to find a bid against almost anything in the face of stronger Asian currencies, which are the main source of funding for NZD longs. On this chart, note the important line of suport at 0.7390 that was threatened already overnight, and the almost crossing 55/200-day moving averages. This pair could see huge follow through to 0.6800 and beyond on breaks of these supports.

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