200-Point Reversal in the Dow Suggests Follow-Through for Carry Trades
The US stock market reversed 200 points in a matter of minutes, triggering a ripple effect in the currency market. Having been up as much as 100 points intraday, currency pairs like GBP/JPY, CHF/JPY, AUD/JPY and EUR/JPY sold off quickly and sharply. The moves in USD/JPY were comparatively mild, but even that currency pair ended the US trading session near its lows. The chance for follow-through selling in Asia and Europe suggest that carry trades could see further losses. However whether a major top is in place remains to be seen since every correction in the Dow over the past month has been met by a new record high in the days to follow. There was no major reason for the reversal, except for the fact that 14,200 proved to be a level too difficult to breach, but a multitude of factors have been blamed. JPMorgan Chase announced that they were cutting staff while the company also lowered their sales estimate for China’s version of Google, Baidu.com, causing massive selling in tech stocks. Around the same time, ECB member Weber warned that the central may need to act given the current level of inflation. This raised the fear that interest rate hikes are still on the table for many central banks around the world. Japan itself will not be joining the party. Last night, they voted 8 to 1 to keep interest rates unchanged at 50bp. Mizuno voted in favor of a rate hike for the fourth month in a row. Economic data out of Japan was weak with machine orders, the current account surplus and money supply all deteriorating, but still, Moody’s upgraded Japan’s debt rating to A1 from Aaa. We still think that the economy is in trouble with deflation a bigger problem than inflation, even though this will have no bearing on how the yen trades (only equity prices will for the time being). Tonight, we have consumer confidence and domestic CGPI, which is an inflation measure; both are expected to be firmer.

Will the US Consumer Hold Up the US Dollar?
The most anticipated US economic data scheduled for this week will be released tomorrow, which are retail sales and producer prices for the month of September. The acceleration of import prices suggest a similar rise in producer prices while retail sales growth is expected to be tepid after a number of small retailers cut their sales forecasts this morning. However the market’s low forecast for retail sales suggest that it won’t take much to surprise to the upside, which is possible given that Wal-Mart raised its sales forecasts. Earlier in the day, the US dollar was helped by the improvement in the US trade deficit as the weak dollar drove exports to a record high. In addition to retail sales and PPI we are also expecting business inventories and consumer confidence. Given that non-farm payrolls in August and September were not that bad, if consumer spending holds steady, then the Fed has absolutely no reason to lower interest rates at the end of this month. The market is currently pricing in one interest rate cut by the end of the year with the greater chance that it will happen in December over October. Tomorrow’s numbers will seal the fate of when interest rates will be cut again.

Euro Tackles 1.42 as ECB Grows More Hawkish
The Euro continued to rise today thanks to stronger inflation data, hawkish comments from ECB officials and buying interest related to the RBS and ABN Amro deal. German wholesale prices quadrupled expectations, illustrating why the European Central Bank has put inflation ahead of growth. According to the October ECB bulletin, growth risks are to the downside, but prices are still a worry. ECB Weber was a bit more direct when he warned that there may be need for extra ECB action given the inflation pressures in the coming months. Junker continues to make comments about the Euro; he says that he supports a strong currency but would not go as far as to say that it is in Europe’s best interest. We have more ECB speeches tomorrow, along with French CPI numbers and Eurozone industrial production.

British Pound: Weakest of the High Yielders
All of the high yielding currencies rallied today with the exception of the British pound as the sterling was weighed down by the RICS house price index which fell to a 2-year low in August. This report indicates that interest in home sales have waned significantly, which may be a major sign that the UK housing market is ready for a turn. Furthermore, the third quarter home sales balance rose to the highest level since the series began in 1989. With the minutes from the latest Bank of England meeting due for release next week, British pound traders will be exceptionally sensitive to any data that provides more information on whether the central bank will continue to raise interest rates. In the meantime, there is no economic data scheduled for release tomorrow indicating that the GBP/USD’s movements will be determined exclusively by the market’s demand for dollars and high yielding currencies.

Australian and Canadian Dollars Hit Fresh Multi-Decade Highs
The Australian and Canadian dollars surged to fresh multi-decade highs on the back of stronger gold and oil prices and better than expected economic data. Like Canada, Australia’s labor market is hot. Even though the number of employed individuals increased less than expected, the unemployment rate fell to 4.2 percent, a new 32-year low. Such tight conditions in the labor market are expected to drive wages higher, giving the Reserve Bank of Australia even better reason to consider raising interest rates. The Canadian trade balance was also stronger than expected, helping to offset the drop in the new housing price index. Tonight, the New Zealand dollar will be in play with retail sales due for release. Consumer spending is expected to rebound after dropping 0.2 the prior month.

Kathy Lien is the Chief Currency Strategist at FXCM.