Forex Meltdown Intensified by Fears of Recession

The Forex meltdown took a life of its own in Asian and European trade, reflecting further deleveraging in equity and credit markets, and especially intensified by the fall out in emerging market currencies and prolonged reaction to remarks from Bank of England Mervyn King using the word recession and anticipating considerable decline in U.K. inflation.

Inflation had long been the main obstacle to those overdue BoE rate cuts among MPC policymakers, and King's remarks comprised a major negative for sterling against all currencies, with USD in particular, as they bolstered the case for a 50-bp rate cut to 4.00% next month, which may be followed by another cut in December to 3.75%.

GBP shed 3.3% against USD on Tuesday and 3.4% in the last 12 hours to produce a 7.6% drop this week so far to reach a five-year low. After a brief recovery to $1.6470, the cable retreated back towards $1.6350, eyeing $1.6320 and $1.6280, baring any rebound in risk appetite, such as fresh rumors of an intermeeting rate cut, as was the case Wednesday morning. GBP/JPY slumped to an eight-year low of 160.54 yen, losing 29% year to date.

EUR hit a fresh 24-month low of $1.2734, while bouncing by as much as five pence against the GBP to a one-week high of 79.10 pence. Euro's selloff against the dollar was largely a result of collective outflows into USD-based funds, whether comprising forced selling due to client redemptions or mobilization of capital to USD-based cash such as T-bills. Oil's decline below $70 and gold's drop to a seven-week low of $747, was $10 above the one-year low reached on September 11. Having breached below our $1.2870 target, EUR/USD faces $1.2480, which was the low from Oct. 2006, lying just above the 50% retracement of the rise from the Feb 2002 low (0.8605) to this year's record high ($1.6038).

JPY remains the outperformer as risk aversion surges anew and Japan's remote positioning from the banking crisis highlights the outflows. USD/JPY prolonged its sell-off to a ten-day low of 98.33 yen. We mentioned last week that any rebound in USD/JPY was limited at 103.00, while on Wednesday we reduced this resistance to 100.50, leading to the conclusion that lower highs reflect authorities' inability to preserve market rallies beyond two consecutive days. Interim resistance stands at 99.55, with targets standing at 98.70, followed by 98.20.

More Rate Cuts, this time from New Zealand, as the central bank is widely expected to cut rates by 100-bps to 6.50%. Despite inflation standing above the RBNZ target, retail sales and housing figures have fallen significantly as of late, underlining the central bank's growth priority, especially in the face of slumping commodity prices. NZD/USD eyes 0.59, followed by 0.5830, while NZD/JPY targets 58.25 yen and 57.20 yen.