Last week's lead bullet point was that the risk rally had stalled, for the moment. Lacking any solid technical indications of a reversal, we could only highlight potential for an upcoming correction in risk assets. This week, however, we have no such hesitation and a plethora of technical evidence that a multi-week top in the risk rally has been made. Ultimately, this should be USD supportive, given recent high correlations and excessive USD short positioning. However, the real driver of USD weakness is near-zero US rates, which will not be changing anytime soon. In light of that, the USD recovery should not be in a straight line, but rather fraught with continued choppiness. As a result, we will look to buy the USD on dips in the weeks ahead against all but the JPY. The JPY remains the primary funding currency, and barring a collapse in US rates in the weeks ahead, this should remain the case. As such, we will also look to re-sell JPY crosses (EUR/JPY, AUD/JPY, GBP/JPY, etc) on any rebounds, and the JPY cross decline is likely to be the most pronounced FX outcome of any risk unwind. Lastly, the outlook for gold remains somewhat confused, given the various forces at work. But our preference is to be sellers while it holds below the 1070/75 area, and we will become more bearishly convinced on a daily close below the 1025/27 level, targeting a move lower to 970/980 initially.

The USD may also benefit from a G20 gathering in Scotland at the end of next week. Market reports suggest European officials, in particular, will press the US to take a firmer tone in defense of the USD, basically asking the US to put some teeth in its much maligned "strong dollar policy." Short of threatening market intervention, it is difficult to envision US officials moving beyond verbal intervention to support the greenback. That does leave open the potential for disappointment coming back to haunt the USD. But a chorus of support from the G20 and intensified US rhetoric, coupled with an overall short dollar position exodus, may be enough to lend the USD additional support.

Fed Speculation Is Misguided

There has been increasing speculation in the market that the FOMC will drop the "extended period" language from their policy statement next Wednesday afternoon. That view was spurred by comments from an advisor to the NY Fed that he could "imagine" the Fed dropping the commitment. We do not expect the Fed to alter that language. Recent FOMC member comments and the minutes of the last meeting suggest a majority of Fed officials are increasingly concerned about the trajectory of the economy as stimulus efforts wind down. The retention of that commitment may provide a brief USD setback and perhaps a respite to stock markets, but we think the overall somber tone of the Fed's outlook will keep that short-lived. More intriguing is the prospect that the Fed will single out the beleaguered USD for comment. Traditionally the purview of Treasury, this Fed spoke out in support of the USD last year as it was near its weakest. The Fed may mention USD weakness as a potential headwind to economic recovery, as it may spawn inflation and undermine consumption. If the Fed speaks out on the USD, it would also signal the rest of the G20, and the ECB in particular, that Washington "gets it" and will be more forceful in defending the dollar. If the Fed statement mentions the word "dollar," we would expect a significant boost for the buck.

Earnings Still Little to Write Home About

With 65% of S&P 500 companies now having reported, the 3Q earnings season continues to look considerably worse. Bottom line earnings (EPS) are indeed beating by 13% on aggregate, but this is down from a 16% surprise one week ago. Meanwhile, sales figures have worsened materially. Last week, aggregate sales figures were about in line with overly conservative estimates. The additional 150 companies or so that reported this week helped ratchet that number down to a -1% surprise. As the sample size grows, it is becoming clearer that EPS was once again driven by massive cost cutting, mainly on the employment front. Organic growth remains non-existent and the consistent +500K prints in the weekly initial jobless claims figures suggest it is still a ways away.

Earnings expectations ultimately drive stock prices and we believe the market is now realizing that perhaps the forecasts in the quarters ahead are overly optimistic. With the S&P 500 trading at a price/earnings multiple well above 20, this makes the case for a short-term top in the equity space even more compelling. The downside pressure in the S&P is alive and well while it trades below the 1050 level and a drop below 1035/1030 suggests a test of the 100-day moving average near 1000 next. Given the US dollar's extremely robust correlation with stocks this year-at better than -90%-we would expect the greenback to continue to benefit from this unwind in risk appetite.

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