Saxo Bank

US employment report may be decisive for Fed rate decision next week. Markets closing in on key technical inflection points.

MAJOR HEADLINES – PREVIOUS SESSION
Overnight developments:

• US Nov. ICSC Chain Store Sales grew 3.5% YoY vs. 2.4% expected and 1.6% in Oct.
• Japan final Q3 GDP growth number adjusted down to 1.5% annualized vs. 2.6% expected
• Australia Nov. AiG Performance of Construction Index fell to 53.2 from 57.4 in Oct.

THEMES TO WATCH – UPCOMING SESSION
Key event risks today (all times GMT):

• Germany Oct. Industrial Production (1100)
• Canada Nov. Unemployment Rate and Net Change in Employment (1200)
• US Nov. Unemployment Rate and Change in Nonfarm Payrolls (1330)
• US Dec. preliminary University of Michigan Confidence (1500)

Market Comments

The market was justifiably surprised at Trichet's hawkish press conference yesterday, in which he only gave a head nod to downside growth risks and then talked up the risk of inflation. ECB inflation projections were even adjusted upwards by 0.5% for 2008. This saw EURUSD bouncing 100 pips off its lows. Trichet's performance was a bit surprising as we suspected that he might try to present a more dovish take on things considering the strength of the EUR. Also, past growth cycles show that inflation is a lagging indicator - take the US core CPI, for example, which didn't top out in the 2001 "recession" until December 2001, while the ISM and growth numbers had been falling all year and Greenspan had already unleashed a series of rate cuts. Of course, the signs of a slowdown in the Euro-zone's case are less starkly evident at the moment, but the ingredients are there for serious concern, and as one article pointed out this morning, the central bank's job is to be pre-emptive rather than merely reactive. Down the road, Trichet is guaranteed to either look like a genius or a fool. He's out on a limb in any case if the EuroZone economy begins to slow sharply. As for EURUSD, it briefly corrected above the 1.4620 resistance line, but may yet fall again on strong US data.

The quick and dirty analysis of the 25 bp BOE cut yesterday: although theoretically not fully priced in by the market, the actual reaction in the UK STIR futures showed that many bets had possibly been placed on a 50 bp easing as the next several contracts closed lower on the day. This could mean that GBP finds a bit of support in the crosses for the short term before falling again.

The US employment report is up today - and the market may be unsure of the outcome. Are we beginning to see a trend developing in the US unemployment rate, which based at the end of last year and spring of this year at 4.4% before rising to 4.7% (today's number expected out at 4.8%). Note that the US unemployment rate is one of the most "trending" indicators you will ever see, as once the index rises or falls for several months in a row, it tends to keep going in that direction for years. The turnaround to an uptrend looks convincing now, even if it can zig and zag from month to month. The troublesome aspect of today's report is that we got conflicting impressions from the strong ADP number on Wednesday while weekly Jobless claims have shown a clear rising trend of late. Some of the big banks were quick to adjust their expectations for today's nonfarm payrolls report upwards after the ADP number: could we be set up for a disappointment? It's a tough call. A very nasty report could get the market more fully pricing in a 50 bp cut next week from the Fed, while a better than expected number together with a stable 4.7% unemployment rate could see the market looking for only 25 bp.

Look for a possible correction lower to parity in USDCAD if the US employment report is weak and the Canadian report is anywhere near as strong as last time around. Yesterday's Ivey PMI number from Canada was very strong and we've seen a sharp rebound in commodity prices yesterday, particularly oil. Still, the new trend is clear in USDCAD - as the "climax reversal" (from just above 0.9000 to current levels well above parity) is a rare technical event to see in FX in recent memory.

Note that the major US equity indices have rallied to close right at their 55-day Moving Averages while the dollar index retreated yesterday after breaking to new recent highs and making a go at its 55-day SMA resistance. Equity markets will be key for the JPY outlook.

As we mentioned yesterday, we're at a tough inflection point technically as the short-term (usd bullish) and longer term (key support for USD bearish scenario) outlooks are at odds. On the fundamental front, it's hard to imagine the market stretching the rate differentials with the other major economies even further into USD bearish territory - so we look for a structural turnaround soon in the USD, though this may take time.

One last note: we are aware of all of the noise in the press on the subprime mortgage relief plan from Bush to bring relief to subprime mortgage holders' interest rate resets. While this is obviously having short term sentiment impacts on the market, we don't view it has having any long term relevance, except perhaps a slight slowing impact on the foreclosure problem in the US and endless lawsuits...

Chart: EURUSD

EURUSD saw a hammer reversal yesterday that is theoretically bullish, though today's event risks are too great for us to want to hop on board for an upside attempt. Note that the 1.4750 "shoulder" area looks like important upside resistance, while a move back below the 1.4525 lows from yesterday could quickly usher in a test of the 55-day moving average. The downside swing level comes in around 1.4575.