The Reserve Bank of New Zealand slashed interest rates by a record 100bp bringing the cash rate down to 6.5%, a move that had been widely anticipated by the markets, citing tight credit conditions and market turmoil as the reasons for the move. The accompanying statement highlighted that the central bank was still concerned about high inflation but added that it would not preclude any further rate cuts. Initial reaction in FX markets saw a weaker NZD but the bird soon recovered some of its poise.

Japan’s Sept trade figures pointed to a disturbing slowdown in export growth, with exports easing 1.3% m/m, the second straight month of declines. Declines were across the globe, exports to the US down for the 13th straight month, but by a somewhat lesser -28.1% y/y pace vs -48.53 y/y prior, whilst exports to the EU pulled back by a more steep -9.0% y/y after a first time -3.5% fall on the August year. Export growth to Asia otherwise slowed to rise by a lesser +2.9% vs +6.6% y/y prior; but the most disturbing was export growth to China; which fell to a mere 1.1% y/y pace vs 8.8% prior in a sign of a global slowdown well underway. Growth in imports was a lofty 28.8% y/y driven by soaring oil and raw material costs at the time. These factors combined to force the trade surplus down to a mere Y95.1 bln vs Y600 bln expected and was down a hefty 94.1% y/y. Today’s Nikkei newspaper carried a story highlighting that most exporters had misjudged the extent of the JPY’s recent rise, having expected EURJPY to trade 155-165 this fiscal year and the article suggested Sony and Honda will be under increasing scrutiny as the gap widens between their budgeted EURJPY rates and current spot levels.

AUD held up quite well o/n into the early Asian session amid market chatter that ConocoPhillips, the third-largest U.S. oil company, had received approval from Australia’s Foreign Investment Review Board to acquire half of Origin Energy Ltd’s coal-seam gas unit. The transaction, worth as much as $8 billion, is now unconditional and Sydney-based Origin expects to receive an up-front payment of $5 billion at the settlement of the deal, expected in about one week, according to a statement to the Australian Stock Exchange today. However, once the order appeared to have been cleared, AUD continued its downward slide given the weak commodity environment.

Activity in Asia was ‘relatively’ muted, with big swings confined to the open. EURUSD jumped 1 big figure on nothing and has slowly drifted off since then. USDJPY grinding lower but JPY crosses more aggressive in their slide as Asian bourses succumbed to broad-based selling, down on average around 4%. AUDUSD still holding up amid talk the corporate buying order referred to above has not yet been taken out.

The Bank of Canada joined in the global rate cutting spree, trimming the overnight target rate by a less-than-expected 25bp to 2.25%. However, rates are now 75bp lower than the start of the month as the BOC participated in the coordinated rate cuts then. The accompanying statement also maintained a dovish tone and highlighted the weakening CAD as an offset to slower economic growth and deteriorating terms of trade. The CAD slumped to a 3-yr low against the greenback and is expected to remain on the back-foot ahead of today’s release of retail sales for August.

Meanwhile, Bank of England governor Mervyn King was particularly downbeat in a speech last night, highlighting that the recapitalization of the banking system was a result of an “extraordinary, almost unimaginable, sequence of events” which had been triggered by the Lehman’s collapse on Sep 15. He referred to the global credit crunch and the slowing in capital inflows into the UK, saying “…Unless they (capital inflows) are replaced by other forms of external finance, the adjustments in the trade deficit and exchange rate will need to be larger and faster than would otherwise have occurred…” This, combined with a 28-year low in UK manufacturing sentiment was the market’s green light to pound GBP lower, GBPUSD hitting a 5-year low below 1.6500 during the Asian session today.

An article in the wall Street Journal picks up on the theme of hefty FX losses at some corporates as a result of the recent sharp FX swings and USD’s resurgence, hot on the heels of yesterday’s news that HK’s Citic Pacific faces losses of up to USD2 bln from wrong bets on currencies. The article suggests that more such problems in other corporates may come out of the woodwork, with a particular reference to Latin America, where problems have already surfaced.

The Asian session saw the theme of broad USD gains continue, with the EUR slicing through reported barrier defense at 1.3000, sliding quite easily to the low 1.29’s, new lows for 2008. Little seems to be able to stand in the way as the pair targets the1.2600-1.2700 window. EURJPY held the 130.0 mark for a while before succumbing under EUR’s pressure, taking out the 2005 low with 125.85 the next target. GBPUSD was also pressured through 1.6500, hitting new 5-year lows, with no sign of any good news coming out of the UK at the moment.

This has been the quietest weekend in recent memory, with no new major policy initiative from officialdom needed to prop up the failing institution or systemic crisis du jour. The US equity market close looked rather weak on Friday after a buying spree sparked by William Buffett’s announcement that he is buying stocks, but the Asian session this Monday opened on a positive note. The standard risk appetite indicators elsewhere are sending mixed signals: interbank lending measures showed a large drop on Friday and the shortest US t-bills showed a rise in yields, but credits spreads on companies were still stretching wider on Friday, and worries over corporate defaults remain very high. In currencies, the JPY was weaker overnight, AUD was stronger and the USD has hardly done anything since Wednesday of last week. Some of the panic pricing in EM - though still within recent “ranges”.

An article in Bloomberg this morning points out that corporate default worries may be too high and that a buyer of a diversified basket of high risk corporate debt would need for almost all companies to go bankrupt to not get their money back on the investment (if historical recovery rates on default are still the case). So clearly, a lot of worry has been priced into this market, and yet few are willing to call a bottom as liquidation pressures from hedge funds and possible mutual funds looking to raise cash for redemptions may offset any investors who have enough funds to take advantage of perceived bargain prices. The biggest owners of cash - Middle Eastern and Asian sovereign wealth funds - are showing increasing signs of activity after a long period of quiet and their liquidity will be much needed. Investment flows could have important FX implications: On the reserve diversification side, central banks are likely to be less active as long as the times look so uncertain and their lack of activity may be contributing to the general liquidity problems. This keeps pressure off the weak USD side of the equation. As well, the sudden glaring weaknesses in the European banking sector, which has shown itself to possibly be even more leveraged and worse off than the remaining American banks are known to be, has also likely given central banks pause on pouring their money into Euros. The other pressure that has eased in the reserve diversification universe is the enormous drop in oil prices - with Middle Eastern OPEC powers, for example, now raking in petro-profits at half the rate they were a mere three months ago. This leaves far fewer funds with which to import European goods. All of these affects are USD positive and EUR negative as long as they last. OPEC is set to meet this Friday (a meeting moved forward from November) and is likely to cut production.

Further USD positive potential comes from US portfolio flows. US investors were massive buyers of EM and other international assets during the boom times as they shunned their own stocks and government debt and sent their money where growth rates were highest. With the fall in equities, Americans have already started bringing their money home and are likely to continue doing so as already steep losses mounted further over the last few weeks and EM currency losses adding to the negative calculus. To take a basic example, investors in the iShares Brazil ETF, for example, have seen its value collapse by two-thirds from its May highs this year due to the combined effect of the falling share prices in Brazil and up to a 50% weakening in the country’s currency. That ETF is now back to its Oct, 2005 price level.

We wrote last week about the risk of US confidence “double dipping” and this indeed seems to be the case as the US Michigan Confidence number was far worse than expected - at 57.6 vs. 65.0 expected and close to the June low, which was the lowest since the late 1970’s. The consumer is receiving a real shock as credit lines dry up and a psychological shock from the events unfolding. It can only mean one thing: a change of behavior and far less enthusiastic use of credit - both because of a new perceived need to secure against uncertainty, and because the credit just isn’t there any more. This guarantees a steep recession at minimum.

The week ahead looks quiet on the economic calendar. Three of the G-10 currency central banks are scheduled to meet on rates this week. The Bank of Canada will likely cut 50 basis points to bring its rate to 2.00% - matching the lowest levels from the 2001-3 rate easing cycle. The RBNZ is looking to cut up to 100 basis points (to bring rate to 6.50%) on Thursday and the Riksbank may cut 25 bps on Thursday. There is still plenty more easing to come from the major central banks outside the US/Canada. German 3-month t-bills, for example, ended last week trading around 1.75% - a whopping 200 basis points below the current ECB rate. The ECB is likely going to need to cut deep and cut fast and this could continue to weigh on the EUR in coming months.

Other data this week of note includes the preliminary PMIs from Europe for October, out on Friday, and Retail Sales data from Canada on Wednesday and the UK on Thursday. Momentum seems to quickly be leaking out of the moves in currencies late last week - is this a sign that we will see a consolidation of recent moves (would require equities to continue to find support and rally) or a renewal of the pressures on the JPY, CHF and USD to strengthen (would be triggered by new slide in equities and especially if a new round of systemic risks comes to light.)

We thought the Lehman CDS settlement issue was behind us after last Friday’s auction, which was actually not the settlement, but only the auction intended to determine what Lehman’s senior debt was worth in order to determine how much credit protection sellers would have to cough up in the estimated $360 billion settlement. Apparently, the fall-out from the situation is not over with - while it was initially stated that only a few billion dollars will need to change hands, other sources now claim that the real figure is closer to $250 billion (source of this information is an article over at the Telegraph from the incomparable Ambrose Evans-Pritchard). Have a look at this article for the moral hazard angle as well (AIG - i.e., the US government, having to pay up for the Lehman CDS that it insured.) And next Tuesday is when the actual settlement of the Lehman CDS’ takes place after last Friday’s auction. So it will be interesting to see if liquidation pressures can ease after that date and whether a more sustainable rally in risk appetite could unfold.

The more generalized problem here is that Lehman was just one of hundreds of companies in which CDS are actively traded - and this is causing a wider problem in financial markets. The opaque world of $55 Trillion in CDS contracts means that any counterparty may be on the hook for untold billions if a company goes bankrupt. This situation shows why Warren Buffett called them financial weapons of mass destruction. One wonders if the authorities can step in with some kind of new transparency rules or further “tear ups” to eliminate this risk to the financial system. This will be a key area of focus going forward.

The Philly Fed survey rolled in yesterday at an abominable -37.50, the lowest level since 1990 and indicative of a sharply contracting manufacturing sector. This and the recent Empire Manufacturing number suggest that the ISM for October is shaping up as possibly the worst since the 1990-1 recession as well. The ISM Non-manufacturing number is actually more important as the US economy is predominantly a service economy. This number was miraculously still levitating around 50 the last time around, but is likely to see a sharp drop this month as well. US economic data today includes Housing Starts (can builders really be kicking off the construction of an annualized 872,000 new houses in this economic environment? We wonder about these numbers sometimes. The Sep. number should be bad, but the Oct. number is likely to be shockingly so.) An “as expected” reading would show new housing starts at the lowest since the early 1980’s, when the population was 25% smaller. The NAHB Index measure of interest in new houses plummeted to a new record low in the 23 years of the survey.

Also out later we have the preliminary October reading for the University of Michigan Confidence. It appears from the weekly numbers that confidence is “double-dipping” as the initial bounce in confidence may have only been related to gasoline prices and the average consumer now has much larger things to worry about with this credit crisis quickly spreading to the real economy.

Yesterday showed a healthy rally attempt in the equity markets after a nominal retest of recent lows (missed by a few percent, but that’s not much these days.) Still, the outlook is far from stable here, and we would have to recover enormous ground to bring this market out of the bearish trend in risk appetite - so any guesses at a rally are simply that for now. We still don’t have enough of a contraction in the various credit indicators to build any serious hopes for a rally just yet.

Along with the rally in risk came a rally in crude oil, though only after crude scratched to new lows below 70 dollars. OPEC is out promising to cut production next week and US crude and gasoline inventories are building strongly after a recent supply scare. At these levels, the crude oil price is becoming destabilizing for various exporting powers as their expectations and budget expenditures grew quickly with the risk in oil prices over the last several years. The supply/demand equation will be very interesting going forward. A continued oil rally may provide for a large enough sell-off in USDCAD for brave participants to find new entry levels for longs. EURNOK is also well of its highs, but so far, these moves are relatively small compared to recent trends.

Technical levels to watch in the bigger picture are: 103.00-50 in USDJPY for risk appetite rally (we’re in the red zone in risk as long as this area holds as resistance. For the status of the USD rally, we would focus on the 1.3350 area in EURUSD first. This was the low yesterday and comes in below the 200-week moving average - now around 1.3375 at which the pair closed last week.

As every, be very careful out there.