EUR sympathizes with Sterling

No one really cares that the Spanish 3 and 6-month Bill auction saw a huge improvement over December, with its bid to cover ratio doubling. It’s the fourth quarter UK GDP (-0.5% vs. +0.5%) print that’s caused Cable to plummet and the EUR to sympathize. The extreme cold weather, the unquantifiable factor, had the quarter reflecting a full 1% deviation from the median forecasts. Sterling has found some buyers, but continues to look heavy, with the currency expected to dominate trading even further the longer it cannot find traction. Even with the double-dip fear revived, initial market reaction has overshot the mark. Dealers expect better levels to own EUR/GBP and sell Cable outright.

The US$ is stronger the O/N trading session. Currently, it is higher against 14 of the 16 most actively traded currencies in a ‘volatile’ O/N session.

Today’s US consumer confidence release is the first of a slew of data that is expected to begin a strong week for USD. Combined with large net Treasury issuance, this week’s data could push US yields higher, benefiting the currency. Some of the luster has been taken away by the dismal UK release this morning. Markets are calling for double-dip recession in the UK. The dollar may shine because of uncertainty and not necessarily on the back of stronger data.

The USD$ is higher against the EUR -0.42%, GBP -1.30%, CHF -0.10% and JPY -0.20%. The commodity currencies are weaker this morning, CAD -0.14% and AUD -0.27%. The loonie traded under pressure yesterday, especially on the crosses, but in a tight range ahead of this morning’s CPI data. Oil rhetoric from OPEC members had the CAD trading skittishly in a tight range. The fear of China extending a tighter monetary policy has also had commodity sensitive currencies on the back foot. An unexpected Canadian November retail sales print on Friday (+1.3%) gave the CAD some positive temporary momentum that ended up being an ideal opportunity for some speculative longs to offload their positions. Year-to-date, the loonie has benefited by association with stronger US data. The BOC dovish position, after keeping rates on hold at +1% last week, has also helped to push the loonie to back off from its strongest level in two-years as the market digests rates being on hold and an economic recovery being threatened by a European fiscal crisis. Investors will see if the dovish BOC stance is justified after this morning inflation numbers. If so, expect dealers to be pricing rate hikes even further out the curve (0.9963).

The AUD immediate reaction was to fall -0.5% after the release of the CPI data showing headline inflation falling to +2.7%, y/y from +2.8% in the fourth quarter, vs. a market expectation of +3%. Since then, it has managed to claw back some of this losses, but not with much conviction, especially with softer commodity prices widespread. Market pricing of RBA rate hikes for the next 12 months fell to 28bp from 35bp. Weaker inflation and the devastation caused by floods will very likely delay further RBA hikes beyond the first quarter. Futures dealers expect the RBA to resume its tightening bias in the second half of the year, given rising wages, construction and housing related costs and energy and food prices. Last weeks data out of its largest trading partner, China, has the market convinced that the PBOC will move to hike their reserve rates. Their actions will reduce further the demand for the commodity sensitive growth currency. Earlier this week, Treasury Secretary Swann stated that the country faces an ‘enormous’ economic fallout from floods. ‘Queensland’s rapid development has meant that its economic performance has a much bigger influence over our national economy’. With growth expected to slow this quarter, a tightening policy would not be the prudent course of action. Currently, the market pricing of rate cuts (4.75%) for the RBA February policy meeting and of rate hikes later in the year remains broadly unchanged. Offers again appear at parity (0.9937).

Crude is lower in the O/N session ($87.60 -27c). Crude prices never had a chance at taking on the $90 level yesterday, especially after the Saudi Oil Minister indicated that OPEC may increase production levels to meet increasing global fuel demand. His comments have certainly put a medium term cap on the black stuff. He indicated that global demand was expected to increase around +2% this year. Last week the IEA raised its estimates for this year’s global demand for a fourth consecutive month as the economic recovery seems to be gathering momentum. They anticipate that global consumption will increase by +1.69%. Last week’s US inventory report provided another excuse to offload oil contracts. Crude stockpiles increased +2.62m barrels to +335.7m. Not being left behind were gas supplies rising +4.4m to +227.7m barrels. It’s worth noting that the four week gas demand was +2%, y/y, higher and averaged +9m barrels a day. US refineries ran at +83% of total capacity, a drop of -3.4%. The supplies of distillates (diesel and heating oil) rose by +1m to +165.8m barrels vs. an expected weekly increase of +900k barrels. OPEC believes that supply and demand are ‘in balance’. There is far more oil in storage, more fuel capacity and more idle oil wells to limit a stronger market rally in the medium term. The commodity is expected to test key support levels around $85.

After capping its third consecutive weekly loss on speculation that borrowing costs will rise as the US economy recovers, gold prices are again piggybacking their two month lows with some bottom feeders happy to want to own some as global equities rally, eroding the metals appeal. Even the announcement by the Central Bank of Russia planning to buy 100 metric tons of gold to replenish their reserves has done little to spur frantic bullish buying now that key support levels are being tested. To date, buying has been modest in the commodity, off to its worst start in 14-years and down -5.7%, year-to-date, only weeks after recording a +30% return. There is serious discussion being given to whether the gold market has peaked or if it is simply making a short-term correction. Recommendations by hedge funds to cut long positions last week, has the lemming one directional trade firmly eyeing an exit door. Aiding the metal is the Euro sovereign-debt crisis and this despite the Euro-finance minister’s pledge to strengthen a ‘safety net for debt-strapped countries’. On a macro level, analysts expect the losses may be limited on concern that inflation will accelerate. Technical analysts believe that gold ($1,327 -$17.20) will outshine other precious metals in 2011 and peak somewhere above $1,600 in 2012. Current trading however does not feel like it.

The Nikkei closed at 10,464 up+119. The DAX index in Europe was at 7,080 up+13; the FTSE (UK) currently is 5,924 down-20. The early call for the open of key US indices is lower. The US 10-year eased 2bp on yesterday (3.40%) and is little changed in the O/N session. The belly of the US curve printed six-week high yields last week, as economic data in the US and the Euro-zone boosted speculation that a global recovery is building momentum which dampens the need for government debt as an alternate for safe heaven requirements. The 2’s/Bond spread tightened for a second consecutive day ahead of today’s $35 short-bond issue and on speculation that the increases in long-bond rates cannot be sustained (+393bp). In total this week, the Treasury will auction $99b of new debt which should require dealers to make more room to take down product and flatten the curve. Stronger fundamentals are creating a choppy trading environment with medium term support levels for 10’s becoming questionable (+3.50%).

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