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“You may think this is a good time to bet against the yen now that Japan has intervened in the currency market for the first time since 2004. Think again.

“George Soros and his ilk should be betting on yen strength for two reasons. One, Japan sold yen unilaterally, not with the help of the Group of Seven. Two, a top official made the mistake of telling speculators which level to attack.

“Neither action seems particularly bright today. Without the Federal Reserve and European Central Bank on board, yen intervention won’t work. Only the fear of concerted actions will keep Soros types of the world from testing the yen’s ability to rise. And a government should never, ever tell traders their line-of-defense level.”

                           William Pesek

FX Trading – Risk on or Risk Off? The gold versus Euro Correlation just blew out …

Yesterday was a weird day. I say that because the correlations seemed all screwed up. Bonds were weak, commodities were basically flat to mixed (except for the precious kind), US stocks flattish, and yet the currencies were signaling risk appetite is back; well, except for the yen which strengthened big time yesterday (before intervention this morning). So we have considerable mixed signals on whether risk was on or off or taking a vacation.

As we all painfully know at times, risk ebbs and flows. We all do our best to determine ahead of time how risk will be meandering day to day, at least for shorter-term time frame positioning. One of the monikers we were hanging our hat upon has been the gold versus EURUSD connection. It has been fairly tight and possibly logical. But in the famous words of the former great boxer Roberto Duran—no mas!

I used the phrase “possibly logical” above, to describe the gold versus EURUSD relationship. Our story has been that risk in the eurozone has been the driver of players to both the dollar and gold for safe haven. Thus, we see gold rising and the dollar rising when the euro falls. It was not the normal correlation which over time has been even tighter — strong gold and weaker dollar on the idea gold has to maintain its global purchasing power across a basket of international goods and because it is priced in US dollars it goes up when dollars fall in value against the currency pack.

Back to the original point: since the correlation between EURUSD that was tight, has recently blown apart, does it tell us we are again in a position to see a significant weakening of the buck based on risk-on (risk appetite) and recovery clearly underway with the US lagging badly?

Gold (black) versus EURUSD (red) daily: Euro broke out intermediate-term resistance yesterday (going back two months), as gold soared to a new high.

The correlations continue to look a bit screwy again this morning. Long bonds are down ¾ of a point, normally a “risk on” indication, yet US stocks a la S&P futures are bidding slightly lower. Gold and the euro are flat. The big liquidity move from Japan this morning and big run up in the Nikkei did little to help commodities—oil and copper lower so far.

The economic news doesn’t seem to be giving us any more clarity than the correlations. Today a survey of Asian companies showed sentiment declined for the third quarter, despite all the seemingly good news about China being back on track. UK inflation above expectations, but the eurozone flat to down on the inflation front is the report today. Australian consumers have grown less optimistic despite their supposed roaring economy. And despite all the new confidence from US economists telling us we will not follow Japan down the deflationary path (great article on that subject by Robert Feldman of Morgan Stanley here) and there is no way a double-dip recession will happen, yet news from The National Association of Independent Business this morning isn’t very promising and this where many US jobs are supposed to flow from:

Optimism rose a bit in August, but remained stuck in the recession zone established over the past two years, 88.8 is not a good reading and is typical of recessions over the past 35 years of NFIB surveys. Weaker expectations for the economy and sales produced the July decline, and were the major contributors to the improvement in August – but that isn’t saying much. Owners are still expecting sub-par growth in the second half. Half of the Index components posted declines, four posted gains and one was unchanged. Although the macro measures of inflation indicate there is still some, more owners (by as many as 21 percentage points) have reported cutting average selling prices than raising them for 21 months in a row. At least in the small business sector, it’s looking like “deflation”.

Today’s NY Fed Empire State index numbers are weak, but import price data a bit stronger than expected. Hmmm….

So, is risk on or is risk off? Not as clear as it once was.

The US dollar index is higher today, mostly thanks to Japanese intervention. But here too the picture is a bit cloudy as the dollar index is testing key 200-day support. The last time it did this, we saw a major bounce back in early August just as players were getting charged up for yet another dollar crash and big bout of risk appetite evidenced by the new intermediate-term high in the S&P 500 index.

US Dollar Index (black) versus S&P 500 Index Futures (red) Daily: The green line is the 200-day moving average for the dollar index. Notice that if support holds here it will represent a higher low for the dollar. Technically bullish, with Mr. Hindsight needed to confirm of course.

So is risk on or risk off? Not sure. But the screwy price action of late may be telling us something bigger than usual may be in the works and lead to a nice trend one way or another we can play with a bit more confidence. Stay tuned.