Fed's Liquidity Drive Extends Seasonal Reversals

Tuesday's latest liquidity drive from the Federal Reserve gives a fresh jolt to risk-seeking trades, extending my scenario of seasonal reversals in currency and commodity markets put forth last week, typical of the last five-six weeks of the calendar year, whereby markets reverse the flows prevailing in Sept and Oct. In this case, the lower yielding dollar and yen sustain fresh damage, reversing the gains posted in Oct and Sept. Such reversal is seen prolonged into mid December.

The Fed's quantitative easing policy reaches a new landmark as the central bank announces the purchase of up to $500 billion in Government Sponsored Enterprise Mortgage Backed Securities - MBS belonging to Fannie (FNM) and Freddie Mac (FRE) - and an additional liquidity facility of up to $200 billion in new lending to consumer Asset Backed Securities in an effort to stabilize the securitized housing and consumer loan market. The Fed's balance sheet has grown by over $1.3 trillion so far this year and is well on its way of following the Bank of Japan's policy of quantitative easing -- targeting the quantity of money rather than its price.

The Fed's latest announcement overshadowed the revised Q3 GDP report and a bigger than expected 17% decline in the September S&P/Case Shiller Home Price Index.

U.S. preliminary Q3 GDP was revised to -0.5%, while personal consumption revised to -3.7% from -3.2%.

Sterling surged to a three-week high of $1.5393 from a session low of $1.4980 largely on the Fed's latest jolt of liquidity. Sterling was initially dragged by renewed remarks from BoE officials highlighting the need for further interest rate cuts as commercial banks were slow to pass though rate cuts. Cable breached the 38% retracement of the decline from the 1.6672 high (Oct 30) to the 1.4558 low, eyeing preliminary resistance at 1.5440. Support started at $1.5240, backed by $1.5180.

EUR/USD regained the $1.30 level for the first time in three weeks, boosted by fresh bids, as orders reverse euro shorts partly on the Fed's liquidity announcement and partly on what we have warned to be year-end seasonal reversal in currencies and commodities. We expect EUR/USD to extend gains towards $1.3080, followed $1.3130. Key resistance stands at $1.33. German Q3 Final GDP fell 0.5% q/q and rose 0.8% y/y.

The Yen's declines are faring relatively modestly in light of the accelerating declines in housing prices, offsetting the effect of the Fed's announcement. Resistance was seen standing at 96.60, followed by 97.00. Support cropped up at 94.80.

The Canadian dollar accelerated its gains, dragging USD/CAD from 1.2479 to 1.2124 mainly on the better than expected 1.1% increase in retail sales, and the 0.8% jump in core sales (ex autos), which was four times greater than expectations. CAD is also gaining on the jump in risk appetite, which is positive for commodities. I warned in Monday's Intraday Market Thoughts of USD/CAD reaching 1.24 on risk-driven reversal in currency and commodity markets. Accordingly, resistance was seen imposing at 1.27, while downside targets were seen extending towards 1.20.