- US NFP disappoints and the USD rebounds

- Possible bailout for bond insurers

- ECB, BOE and RBA to decide on rates next week

- Key data reports and event for next week

- US NFP disappoints and the USD rebounds

Come again? The seemingly incongruent reaction is best explained, I think, through the lens of risk aversion. The unexpected loss of jobs reinforced fears that the US economy was tipping further towards recession, and this alarmed risk-seeking investors, who had been emboldened in recent days by stock market gains and a stabilization in the outlook following an additional 125 bps of Fed easing in January. Risk aversion had dropped off significantly over the week up to the NFP release, leading gold and stocks to reach their best levels in a while. For a moment, it seemed as though the markets worst fears were not going to be realized, and carry trades (long JPY-crosses) and stock prices were near their highs. Then came the NFP which jolted traders nerves and led to a widespread liquidation of risky assets. Gold, oil, and JPY-crosses all plunged in the aftermath, and as we have seen repeatedly in recent weeks and months, when risky assets are unloaded, the USD benefits. So rather than a USD-specific causation, a sharp deterioration in the risk environment was the ultimate take-away from the weaker NFP report.

There was also a unique Forex element to todays price action. The all-time high in EUR/USD at 1.4965/70 was in sight in the run-up to the January employment report. Longer-term players who think the USD has bottomed were primed to sell into any tests of that high and the key 1.5000 level just beyond, setting up a major obstacle to further EUR/USD gains. It looks as though the selling interest was even larger than thought and once the pre-NFP price level was breached after the spike higher, shorter-term EUR/USD longs were forced to bail out, triggering a wave of stop-loss selling all the way back down to below 1.4800. In Cable (GBP/USD), the psychological and technically significant level of 2.0000 was also within reach, but with the BOE set to cut rates next week, Cable buyers were going against the grain. The spike higher in GBP was the briefest of all the majors and you had to be fast if you wanted to just get out at the pre-NFP level. Subsequent liquidations led to a similar collapse in Sterling.

Possible bailout for bond insurers

Risk aversion has undoubtedly risen in the short-run, but I am also seeing some indications that a larger improvement may be developing. Regular readers of this report will know that I have been cautioning for some time about the potential for ratings downgrades to the major bond insurers, known as monolines, which would likely precipitate additional multi-billion dollar write downs by the financial industry. News at the moment indicates a consortium of major US and international banks is working with the NY State Insurance Dept. on a plan to raise capital for the monolines, with one specific firm as the primary rescue target. If a plan is worked out, and there is no guarantee a deal will be reached, a major disaster will have been avoided, or at least postponed for a while. Mind you, the monolines woes are just one piece of the financial sector mess that is currently being sorted through, but rather than an inexorable deterioration, the sector may in fact be stabilizing.

Stocks in particular have proved highly sensitive to the plight of the monolines. Recall that US stocks continued to fall even after the surprise inter-meeting 75 bp rate cut by the Fed on Jan. 22. Only when news surfaced that the NY State Insurance Dept. was convening meetings to shore up bond insurers did stocks find a bottom and begin to rally. Looked at from that angle, the modest gains in US stocks on Friday suggest that the news of a monoline bailout (along with the Microsoft/Yahoo merger) has been able to offset the negatives of a weak NFP. In technical terms, Friday closes above 12,600 in DJIA and above 1284 in the S&P 500, both derived from Ichimoku charts, suggest significant upside potential is coming into play. I would also note that, Fridays sell-off notwithstanding, the JPY-crosses are still toward the upper-end of recent ranges, with GBP/JPY the notable exception. Relative JPY-cross strength is another indication of receding risk aversion overall.