The bears in Wall Street had the lost word on Friday and it was loudly heard in Asia when both the Hang Seng and Nikkei indices dropped 4% on Monday. European stocks are down 2% awaiting US December new home sales. Wednesday’s FOMC decision heads a series of important US data and economic figures, which include consumer confidence (Tues), advanced Q1 GDP (Wed), Dec personal spending and core PCE (Thurs), and US Jan employment payrolls and Jan manufacturing ISM (Fri). The major question is whether the Federal Reserve will ease by as much as 50-bps or only 25-bps after markets surmised that the catalyst to the Fed’s 75-bp cut was extensive selling arising from a single bank -- Societe Generale’s $7.11 billion loss -- rather than a broader damage in confidence.

But considering that markets last week had priced as much as a 35% chance of 0.75 bp for Wednesday and given the Fed’s shift towards a more aggressive easing strategy, we see the possibility of a half point at only 50% versus 50% for a 25-bp cut. Although the intensity of the Fed’s moves has been primarily guided by market erosion, this week’s data may determine whether the macro economic arguments will maintain the central bank’s fear factor into the coming months. An unexpectedly low figure in Q1 GDP below 0.9% (versus expectations of 1.2%) and further increase in the Jan unemployment rate to 5.1% will confirm that recession is here.

The 10 am EST release of Dec new home sales is expected at 645K from 647K, yet we do allow for the possibility for a greater 3% loss to 625K.

The 7 pm presidential State of the Union Address is expected to focus on pushing Congress to approve the $150 billion stimulus package. Some Congress people have even suggested the addition of food stamp provisions. But markets have already shown their displeasure of the cash back plan, which will not only be too little but too late (checks possibly distributed in June).

One way to highlight the potential damage of the current situation is the inefficacy of the Fed and Federal Government’s hands in rescuing the economy as seen in an increasingly lackluster reaction by the financial markets in the face of unprecedented measures (Fed’s 125-bp easing in 8 days). The triple combination of falling market liquidity, increased insolvency and weakening corporate and household fundamentals (seen via earnings warnings and falling expenditure) may be complemented by a fourth element, namely falling incomes. As these arise from rising unemployment, the economy can come to a stand still beyond one quarter, at which point the decoupling theory of global economic growth will be severely challenged.

The S&P 500 charts suggest that further declines are in store ahead of the Fed meeting as markets force the central bank into pursuing the more aggressive 50-bp rate cut option. Despite three consecutive daily gains last week, the S&P failed to regain 1,366--previously a key support level and now acting as a major trend line resistance. Interim target stands at the 200-week MA at 1,290. Aside from forcing the Fed’s hands, the fundamental reasoning for further losses may be disappointing data on GDP, new home sales, consumer confidence and unemployment/payrolls.

Yen Strength Seen On Stocks Weakness

Yen crosses stabilized after a selling wave occurred during the Asian session when both the Nikkei and Hang Seng closed down 4%. But the situation in yen crosses stabilized into European trading. The habitual yen buying ahead of the US session is expected to accelerate as trading progresses, especially given our expectations for renewed equity selling. Markets will watch the 1300 figure and the 200-week moving average at 1,290. Regardless of talk of a Japanese recession, the yen will be expected to flex its safe haven-low yield-low risk muscle, dragging USD back to 106 and 105.70. Upside remains capped at 106.80.

Euro Gains Limited

Softer than expected Eurozone money supply did not prevent the euros recovery from 1.4660 in Asia to 1.4720 due to the stability in carry trade unwinding. EURUSD remains more firmly supported than EURJPY, with the latter seen testing 155.00. EURUSD remains guided by renewed ECB confirmation of its anti inflation message. Yet the pair continues to display constant selling on the rallies, making the 1.4780 a key short term obstacle. Support stands at 1.4620. EURJPY faces resistance at 157.35 with bias drawn towards 155.00