Global Economy Vulnerable As Risk Off Headlines Widespread

• JP Morgan losses seriously diminish credibility in banking sector
• Political saga in Eurozone continues to shake investor confidence
• China economic data disappoints and weighs further on risk correlated assets
• Commodity bloc and emerging market FX exposed
• German; UK inflation mixed

The intense risk-off price action that we saw over the past several sessions looked like it might be poised for reprieve into North America on Thursday, before markets got wind of the disturbing JP Morgan news late in the day. The largest US bank announced a $2B trading loss resulting from some hedges gone bad. While the losses hardly mark a dent in the balance sheet of the banking giant, the news could create a more significant risk off reaction given how JP Morgan has made its stellar reputation throughout the crisis; one of being so far away from reckless trading errors resulting in losses of billions of dollars. Now that JP Morgan has come out with such a loss, it opens the door for similar losses from other major financial institutions and severely diminishes the credibility in the baking sector once again. Many investors are wondering if other banks shouldn't now mark their trades to market so a clearer picture can be afforded on where things lie.

Relative performance versus the USD Friday (as of 10:10GMT)

EUR +0.09%

CHF +0.08%

JPY +0.04%

NZD -0.14%

GBP -0.23%

CAD -0.26%

AUD -0.37%

In our view, the global economy is still standing on shaky ground, and we are not at all surprised to see these developments. We have been arguing for some time that equity markets have been too well bid this year, and we continue to project additional weakness over the coming weeks. The JP Morgan news is certainly a welcome headline for the Eurozone, with the story taking some of the attention away from the political turmoil in Greece and the impact it is having on the broader economy. While the local government is trying to piece together a solution that will keep the existing framework and game plan intact, there is clearly a new regime opposed to the idea of austerity and a regime that will be resistant to the changes that were already in motion pre-election. The prospect of a Greece exit can not be ruled out, and more importantly, investors are concerned of the impact this might have on other countries like Italy and Spain. All in all, the North American continent has been shaken with bad news, Europe is still struggling with its own troubles, and things are now no better in the east.

The latest round of economic data out of China is quite discouraging in our opinion, and continues to highlight the ongoing slowdown that is materializing in this major economy that many had thought was immune to the global crisis. The softer than expected industrial production and retail sales prints only help to reaffirm our view that the Chinese cool down is reflective of the third phase of the global recession. The third phase which has officially kicked into gear should expose some of the highly correlated markets like the commodity bloc economies and emerging markets. As such, we continue to project underperformance in currencies like the Australian Dollar, New Zealand Dollar and Canadian Dollar going forward, against the lower yielding major currencies. Emerging market FX looks to be even more exposed, and currencies like the South African Rand, Mexican Peso and Turkish Lira could be at risk for major declines into the second half of 2012.

On the day thus far, it seems as though market participants are content booking some profits on the latest moves, to allow for some short-term corrective price action. Germany inflation numbers were slightly higher, while UK data of the same nature was mixed. Also released in European trade were the European Commission's economic growth forecasts which were rather subdued as to be expected. There was some upbeat chatter out of Greece with rumors making the rounds of a coalition government. Looking ahead, Canada employment data and US producer prices will be the key economic events in the North American session. Still, we would recommend keeping a close eye on US equity markets for a better sense of the overall risk appetite.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: The market has finally cleared some key support by 1.3000 and the break opens the door for deeper setbacks over the coming days towards the 2012 lows from January at 1.2620. However, short-term technical studies will need to unwind from oversold readings before we are to see any extended declines below 1.3000, and we recommend looking to sell into rallies into the 1.3150-1.3200 where a fresh lower top is now sought. Ultimately, only back above 1.3300 would delay.

USD/JPY: The latest pullback from the 2012, 84.20 highs is viewed as corrective and it looks as though the market could still see a bit more weakness before considering the possibility for the formation of a medium-term higher low. Overall, this is a market that has undergone a major structural shift in recent months and we now see the pair in the early stages of a longer-term up-trend. Ultimately, only a weekly close back under 78.00 would negate.

GBP/USD: Finally starting to see signs of a medium-term top and potential 2012 high after the market has stalled and retreated from the 1.6300 area. Key support now comes in by 1.6065 and a break and close below this level will confirm bearish bias and accelerate declines towards 1.5800 further down. Ultimately, only a break back above 1.6300 would negate and give reason for reconsideration.

USD/CHF: Our core constructive outlook remains well intact with the latest setbacks very well supported by psychological barriers at 0.9000. It now appears as though the market could be looking to carve a fresh higher low, and we will be watching for additional upside back towards the recent range highs at 0.9335 over the coming sessions. Above 0.9335 should then accelerate gains towards the 2012 highs by 0.9600 further up. Ultimately, only back under 0.9000 delays and gives reason for pause.

--- Written by Joel Kruger, Technical Currency Strategist

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