Last week, and the month of October, ended with a strong uptick in risk appetite, which some have likely attributed to portfolio rebalancing (any portfolio operating on the principle of fixed percentage allocations of equities vs. bonds would have some serious adjustments to make after US stocks, for example, lost as much as 25% or more intramonth). The next couple of weeks will be an interesting test of whether this is true as we also have to consider the risk of further liquidation amid signs many hedge funds under major stress. Some hedge funds have 45-day notice periods and November 15 would coincide with the notice period for end of the quarter and end of the year.
Besides these risks we have to consider whether any market participants are awaiting the results of the US presidential election to determine what to do next. Some polls give Obama a historically large margin of victory, but there seems to be a loud hubbub of analysis questioning the accuracy of polling and suggesting that McCain still has a chance due to large undecided contingents. The uncertainty may be great enough, therefore, that some are putting off their decision making until the results are in late Tuesday evening in the US. The markets have been so concentrated on the risk environment and signs of economic activity that we have seen remarkably little coverage of the implications of the election on the financial landscape. We have no view at the current time on any possible short term effects of tomorrow's decision. As for the medium term, the economy has worked up so much inertia on the downside that whoever is elected will have to wait a very long time before any new policy initiatives bear any fruit. Still, we recognize that the election of a new president could cause temporary consumer sentiment shifts that affect survey numbers and the like for a few months after the election and after he assumes office - the so-called grace period that every new president is given.
Australia was out overnight with some very ugly Retail Sales data, though AUD rallied on the back of stronger commodities and equities. Tonight, the RBA is expected to trim another 50 bps off the Cash Target. AUD has recovered very sharply of late - will tonight mark a turning point? The Chinese manufacturing PMI is showing further contraction in the manufacturing sector - a very dangerous sign for the Chinese economy considering its reliance on its export machine. The PBOC has been cutting rates lately and is looking at ways to stimulate its way out of the terrible capacity overhangs that await the economy if it can' light a fire under consumers. Also, it will likely look at huge new public works projects as a way to ensure that oversized capacity doesn't threaten a bust. How China navigates the global economic weakness will be a huge issue to watch in the coming year.
The action in the Asian session overnight was rather sharp considering the lack of new developments, and we wonder whether it is trustworthy for establishing the short term direction. After all, liquidity conditions are awful and Japan was off for a holiday - so the participation must have been practically nonexistent. We would look with a jaundiced eye on any further rally in risk appetite in the short term. Still, this is a very difficult trading environment as the two-way action is very wide and makes finding entry levels difficult.
We have an action packed week ahead of us in the US to say the least: ISM Manufacturing today, US election tomorrow, ISM Non-manufacturing on Wednesday, and the Employment report on Friday.
The ECB and the BOE are looking at rate cuts this Thursday, with more and more noise developing on whether the BoE could slice by 100 bps rather than the baseline 50 bps. ECB will likely cut rates 50 bps.
Chart: GBPUSD
GBPUSD found support ahead of 1.6000 on Friday and is looking higher again - it looks like the zone defined by the last Thursday high above 1.6650, the previous low around 1.6790 and the 21-day moving average currently coming in around the same level is a key area. If this area doesn't hold, then the countertrend rally could extend toward the 1.7000-1.7300 zone. Our view on the short term lacks conviction, but in the bigger picture, we would be looking for fresh levels to sell. GBP is also looking stronger vs. the EUR in the short term, with EURGBP shorts a possible tactical play as long as this bout of risk appetite lasts.
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