Friday, April 29, 2011

The Real Fairytale!

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By Mike Conlon | April 29, 2011

This morning is all about fairytales as the Royal Wedding in the UK has drawn the attention of watchers worldwide and has also closed London for business today as it is a bank holiday. However, the real fairytale may be the news and data we have been seeing here in the US and the policy responses to them.

Yesterday’s declining GDP figures here in the US show that Bernanke’s QE2 policy has been a near-failure and is going to drag the US and then the global economy down again. The Fed’s insistence and denial that they have caused commodity inflation is intellectually dishonest, and now the effects are starting to come home to roost.

As input costs increase, businesses have to squeeze costs to maintain profitability and one of the most efficient ways to do this is to fire workers. Businesses then pass along these costs to the consumer, who can’t afford these new higher costs as the majority of their disposable income goes to pay for increases in the price of food and energy.

The US consumer makes up some 70% of US GDP, so if consumer spending on discretionary items decreases, then demand for good will also decrease, putting further strain on businesses. Thus the deflationary cycle begins again. The weak US dollar is a direct reflection of this sentiment, and how much lower it can go without causing a major global economic crisis is anyone’s guess.

In the Euro zone, most economic data was negative this morning including German retail sales figures, but CPI came in higher than expected and the Dollar is weak so the Euro is trading higher.

Canadian GDP is due out later this morning which is expected to show neither expansion or contraction.

In the forex market:

Aussie (AUD): The Aussie is mostly higher as weak Dollars are driving demand for carry trades and yield-seeking.

Kiwi (NZD): The Kiwi has also rebounded today as trade balance figures due to higher exports came in better than expected.

Loonie (CAD): Canadian GDP figures have just come in and are worse than expected, showing a quarterly decline of .2% vs. an expectation of no-change, pushing the YoY figure down to 2.9% vs. the expectation of 3.1%. Canada’s close economic ties to the US are the possible culprit, as well as higher inflation. (Click chart to enlarge)


Euro (EUR): The Euro is mixed as a weak Dollar is driving it higher as are higher then expected CPI figures, showing a gain of 2.8% which was slightly higher than the expected 2.7%. German retail sales figures though came in negative, and confidence figures have been falling.

Pound (GBP): Today is a bank holiday in the UK in honor of the Royal Wedding. The Pound is slightly lower against all but the Dollar.

Dollar (USD): Another day, another weak dollar. Personal income and spending data came in slightly higher than expected, and later this morning consumer confidence figures are due.

Yen (JPY): The Yen is strengthening as the US dollar is losing some of its safe-haven status and money flows out of USD and into Yen. Despite the problems in the Japanese economy, it is starting to look like a more attractive place to invest than the US. (Click chart to enlarge)


The fairytale we have been living in for the past year is soon coming to an end. Like any good story, it has to end somewhere and whether or not there will be a happy ending is up for debate.

What we do know so far is that QE2 has not been the economic savior we have been looking for, and Bernanke is no white knight looking to come to the rescue. Instead we have been given an unlikely choice of hero thrust into a situation way over his head, with a lack of proper tools and skills to get the job done.

Like all fairytales, we want them to work out in the end. However, the global economy is not fantasyland and the more real we become about the situation, the more dire it looks.

So let’s save the fairytales for Royal Weddings, shall we?

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Canadian Dollar Weaker on Slowing Economy

The Canadian dollar â€" known as the “loonie” â€" lost ground to the US dollar this morning on news that the Canadian economy expanded by an annualized rate of 2.9 percent in February. This is the lowest increase in a year and contributed to the loonie’s 0.1 percent to 95.13 cents against the US dollar from 95.06 cents yesterday.

“GDP was a little weaker than expected and what that’s really done is push expectations of a rate hike from BOC from July to September,” said Blake Jespersen, director of foreign exchange in Toronto at Bank of Montreal.

Source: Bloomberg

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Dollar will Rally when QE2 Ends

In shifting their focus to interest rates, forex traders have perhaps overlooked one very important monetary policy event: the conclusion of the Fed’s quantitative easing program. By the end of June, the Fed will have added $600 Billion (mostly in US Treasury Securities) to its reserves, and must decide how next to proceed. Naturally, everyone seems to have a different opinion, regarding both the Fed’s next move and the accompanying impact on financial markets.

The second installment of quantitative easing (QE2) was initially greeted with skepticism by everyone except for equities investors (who correctly anticipated the continuation of the stock market rally). In November, I reported that QE2 was unfairly labeled a lose-lose by the forex markets: “If QE2 is successful, then hawks will start moaning about inflation and use it as an excuse to sell the Dollar. If QE2 fails, well, then the US economy could become mired in an interminable recession, and bears will sell the Dollar in favor of emerging market currencies.”

The jury is still out on whether QE2 was a success. On the one hand, US GDP growth continues to gather force, and should come in around 3% for the year. A handful of leading indicators are also ticking up, while unemployment may have peaked. On the other hand, actual and forecast inflation are rising (though it’s not clear how much of that is due to QE2 and how much is due to other factors). Stock and commodities prices have risen, while bond prices have fallen. Other countries have been quick to lambaste QE2 (including most recently, Vladimir Putin) for its perceived role in inflating asset bubbles around the world and fomenting the currency wars.

Personally, I think that the Fed deserves some credit- or at least doesn’t deserve so much blame. If you believe that asset price inflation is being driven by the Fed, it doesn’t really make sense to blame it for consumer and producer price inflation. If you believe that price inflation is the Fed’s fault, however, then you must similarly acknowledge its impact on economic growth. In other words, if you accept the notion that QE2 funds have trickled down into the economy (rather than being used entirely for financial speculation), it’s only fair to give the Fed credit for the positive implications of this and not just the negative ones.

But I digress. The more important questions are: what will the Fed do next, and how will the markets respond. The consensus seems to be that QE2 will not be followed by QE3, but that the Fed will not yet take steps to unwind QE2. Ben Bernanke echoed this sentiment during today’s inaugural press conference: “The next step is to stop reinvesting the maturing securities, a move that ‘does constitute a policy tightening.’ ” This is ultimately a much bigger step, and one that Chairman Bernanke will not yet commit.

As for how the markets will react, opinions really start to diverge. Bill Gross, who manages the world’s biggest bond fund, has been an outspoken critic of QE2 and believes that the Treasury market will collapse when the Fed ends its involvement. His firm, PIMCO, has released a widely-read report that accuses the Fed of distracting investors with “donuts” and compares its monetary policy to a giant Ponzi scheme. However, the report is filled with red herring charts and doesn’t ultimately make any attempt to account for the fact that Treasury rates have fallen dramatically (the opposite of what would otherwise be expected) since the Fed first unveiled QE2.

The report also concedes that, “The cost associated with the end of QEII therefore appears to be mostly factored into forward rates.” This is exactly what Bernanke told reporters today: “It’s [the end of QE2] ‘unlikely’ to have significant effects on financial markets or the economy…because you and the markets already know about it.” In other words, financial armmagedon is less likely when the markets have advanced knowledge and the ability to adjust. If anything, some investors who were initially crowded-out of the bond markets might be tempted to return, cushioning the Fed’s exit.

If bond prices do fall and interest rates rise, that might not be so bad for the US dollar. It might lure back overseas investors, grateful both for higher yields and the end of QE2. Despite the howls, foreign central banks never shunned the dollar.  In addition, the end of QE2 only makes a short-term interest rate that much closer. In short, it’s no surprise that the dollar is projected to “appreciate to $1.35 per euro by the end of the year, according to the median estimate of 47 analysts in a Bloomberg News survey. It will gain to 88 per yen, a separate poll shows.”

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Tuesday, April 26, 2011

Transparency But Not Truth!

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By Mike Conlon | April 26, 2011

Tomorrow will the be the first of the new, transparent Fed where Bernanke will attempt to get out in front of the population and attempt to get people to suspend their disbelief. While the Fed Chairman is clearly on the wrong side of public opinion with QE2 and the inflation it has caused, trying to convince people that what they are feeling in the economy is wrong just won’t work.

The reason is because there will be no truth to go along with the transparency. It will be very difficult to sway public opinion that there is no inflation when people see it in their daily lives. The debate over which metric of CPI to use to see the true effects of policy have left people with a lack of confidence in those in power. How this speech tomorrow will change this sentiment is anyone’s guess.

So in my opinion this will all amount to much ado about nothing, with the markets hanging on every word spoken, though I don’t think we will learn anything new.

Europe is open again after yesterday’s holiday and European stocks are higher as are US equity futures to start the day. Asian stocks were lower as are commodities, though today can’t be classified as either a risk-taking or risk-averting day.

In the forex market:

Aussie (AUD): The Aussie is higher as interest rate differentials and carry trades are driving market sentiment despite mild risk taking in the marketplace. An index of leading indicators came in higher than expected.

Kiwi (NZD): The Kiwi is the biggest gainer this morning ahead of tomorrow’s rate policy decision as maybe the market is sensing that the RBNZ could turn hawkish again. While the current expectation is the rates will be left unchanged, the added benefit of Dollar weakness has been driving price action.

Loonie (CAD): The Loonie is also mostly higher despite oil prices pulling back to just above $112. Friday’s GDP report will give more clarity into the Canadian economic situation.

Euro (EUR): The Euro is mixed this morning as both Dollar and Yen are weaker, though reports about a possible Greek debt restructuring have left the market un-phased. CPI data due out tomorrow is expected to show higher inflation.

Pound (GBP): The Pound is lower across the board ahead of tomorrow’s GDP report. CBI business optimism figures came in slightly lower than expected, and perhaps the distraction of the Royal wedding later this week has left the markets unimpressed with the Pound. (Click chart to enlarge)


Dollar (USD): The Dollar is weaker across the board ahead of tomorrow’s Fed meetings. There is increased speculation that the Fed will somehow try to continue to support the economy even though QE2 is expected to end in June. Consumer confidence figures are due out later this morning.

Yen (JPY): The Yen is also lower as the expectation of continued weak monetary policy has pushed traders toward higher yielding currencies. Retail sales figures are expected to show big declines later this evening, ahead of Thursday’s rate decision.

While I expect little in the way of learning something new tomorrow from the Fed, there is always the possibility of a surprise. However, the Fed has been pretty clear about its stance and its denials of inflation so I highly doubt that will change anytime soon.

But the market may be more concerned with how the Fed plans to exit QE2 and what that will do to the economy. What is clear is that the Fed needs to pick up the slack for the inaction occurring on the fiscal side of the equation, with politicians in Washington unable to work together.

Don’t expect to walk away from this new Fed format tomorrow with a warm and fuzzy feeling about the direction the US is going, and continue to be cautious. While there is always major volatility surrounding the FOMC meetings, I could see tomorrow turning out to be one big dud.

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Greek Debt Higher Than Expected

Greece’s deficit for 2010 was a higher-than-expected 10.5 percent for 2010 surpassing the projected 9.4 percent shortfall by more than a full percentage point. The news sent Greek bond yields higher and drew fresh comments suggesting Greece will require further assistance to avoid insolvency.

“I don’t think that Greece will succeed in this consolidation strategy without any restructuring in the future, or perhaps also in the near future,” Lars Feld, a member of the German government’s council of economic advisers, told Bloomberg Television’s Nicole Itano in Frankfurt. “Greece should restructure sooner than later.”

Source: Bloomberg

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Economic Theory Implies Canadian Dollar will Fall

Sometimes I wonder if I’m living in the clouds. All of my recent reports on the Canadian dollar were twinged with pessimism, and I argued that it would only be a matter of time before reality caught up with theory. While the continued surge in commodities prices has confounded everyone’s expectations, but other economic trends continue to work against Canada. In other words, I think that there is still a strong argument to be made for shorting the loonie.

To be sure, the rally in commodities prices has been incredible- nearly 50% in less than a year! Oil prices are surging, gold prices just touched a record high, and a string of natural disasters have driven prices for agricultural staples to stratospheric levels. Given the perception of the Canadian dollar as a commodity currency, then, it’s no wonder that rising commodity prices have translated into a stronger currency.

As I’ve argued previously, rising commodities prices are basically an irrelevant â€" or even distracting â€" factor when it comes to analyzing the loonie. That’s because, contrary to popular belief, commodities represent an almost negligible component of Canada’s economy. Canadian exports, of which commodities probably account for half, have recovered from the recession lows of 2009. On the other hand, the value of Canadian exports are basically the same as they were 10 years ago, when one US dollar could be exchanged for 1.5 Canadian dollars.

Consider also that Canada now imports more than it exports, and that the Canadian balance of trade recently dipped into deficit for the first time since records started being kept 40 years ago. Its current account has similarly plunged, as Canadians have had to finance this through loans and investment capital from abroad. Based on the expenditure approach to GDP, trade actually detracts from Canadian GDP. Any way you perform the calculations, commodities are hardly the backbone of its economy, account for about 15% at most.

As if that weren’t enough, the press is full of stories of Canadians that think their own currency is overvalued. Businesses complain that they can’t compete, and that banks won’t lend them the money they need to upgrade their facilities and become more efficient. Meanwhile consumers whine about higher prices in Canada, compared to the US. I think it’s very telling that their is now a 2-hour wait to cross the border from Vancouver, and shopping malls on the American side have reported a huge jump in business. Even the famous Big Mac Index shows that the price of a hamburger was already 12% higher in Canada back when the loonie was still hovering around parity with the US Dollar.

One area that higher commodities prices will be felt is inflation, which is nearing a two-year high and rising. At 3.3%, Canada’s CPI rate is now higher than in the EU. Given that the European Central Bank hiked rates earlier this month, it probably won’t be long before the Bank of Canada follows suit. In fact, forecasters expect the benchmark rate to rise by 50-75 basis points by the end of the year, from the current 1%.

This might excite carry traders, but probably few others. Besides, given that other central banks will probably raise rates concurrently, it can’t be assumed that carry traders will automatically gravitate towards the Canadian dollar. Not to mention that as I pointed out in my previous post, the carry trade is hardly a risk-free proposition. In this case, an interest rate differential of only 1-2% probably isn’t enough to compensate for the risk of a correction in the USD/CAD.

And that is exactly what I expect will happen. The fact that the loonie has shattered even the most optimistic forecasts is not cause for bullishness, but rather for concern. According to the most recent Commitment of Traders report, net long positions are reaching extreme levels, and it’s probably only a matter of time before the loonie returns to earth.

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Monday, April 25, 2011

Good Friday!

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By Mike Conlon | April 22, 2011

But not good for forex trading!  Central banks are closed around the globe so liquidity is absent from the market.

I would avoid trading today even though the forex market is open, unless you want to line your broker’s pocket!

Happy Easter to those who celebrate it! 


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Forex Week in Review: April 16-21

It was a compact volatile trading week with the dollar hemorrhaging against all of its G10 trading partners and that includes Japan. With rate divergence influencing trade positions, this dollar bear market potentially still has ways to go. Some of the market moves have been exaggerated because of the lack of holiday liquidity, but, the dollars intention remains the same, and that is to underperform. The last dollar bear market between 1985 and 95 implies that the buck has ‘approximately-2% further to fall to match its depreciation at the same point in the bear cycle’.


  • Greek government denies press reports on restructuring.
  • Finnish elections saw an unexpectedly strong showing for the anti-EU True Finns party. The result could complicate negotiations over an EFSF package for Portugal and the mechanism for enlarging the EFSF.
  • Spain successfully auctioned their bills, but at a lower bid-to-cover than at the previous auction.
  • Euro-zone flash PMI’s surprised to the upside (57.7 vs. 57.5), showing little negative impact from the Japanese earthquake or higher oil prices.
  • German PMI manufacturing on hold at record highs (61.7).
  • Euro-zone services PMI moderated slightly from 57.2 in March to 56.9 in April, held down by a lower German print. The surveys continue to be consistent with very strong GDP growth at around 3% and supports expectations of additional ECB tightening, while at the same time reducing the expected impact of fiscal stress in the periphery.
  • Finnish Prime Minister-elect backs Portuguese EFSF, but suggested that the Portuguese program may require some changes to secure Finnish approval.
  • Riksbank hiked +25bp to +1.75% and revised CPI forecast higher.
  • Spain sold €2.4b of 2021 bonds and €885.2m of 2024 paper to strong demand, supporting market expectations of the sovereign’s ability to weather its maturity schedule without resorting to EFSF funding.
  • BoE April Minutes showed an unchanged voting pattern. Six members voted for leaving rates unchanged and three members voted for a rate hike. The sentence, indicating that some members from the dovish camp saw the case for rate hikes strengthening has been removed.
  • Greek inverted 2/10’s yield curve spread reaches fresh extremes-1,244bp
  • A soft German Ifo print for April (110.4 vs. 111.1). The level continues to point to very solid growth.
  • UK Retail sales surprised to the upside with a +0.2%, m/m, gain in March (ex-petrol). In real terms, sales are flat on the quarter and rising only +1.0%, q/q in nominal terms due to the VAT hike in January. No real reason to hike rates any time soon.
  • M3 and mortgage growth remained steady in Switzerland. M3 growth moderated slightly to +7.1%, y/y, while mortgages grew at +4.5%, y/y. This is should not impose any pressure on the SNB to consider policy tightening.


  • S&P cut the US long-term credit outlook. “The US government risks losing its AAA credit rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt”.
  • March US headline housing starts (+7.2% or 0.55m) bounced back from February’s very low levels (-18.5%), but the details suggests the US housing sector remains very weak. Building permits have climbed +11.2%, m/m, to an annual rate of +594k. However, year-over-year, overall new home construction was down -13.4%.
  • Canadian inflation data beat all analysts expectations, marking the biggest monthly headline gain in 20-years (+1.1% vs. +0.3%) and the largest annual advance in nearly three-years (+3.3%). It puts the Governor on the back foot to hike in July.
  • Canadian leading index rose faster than expected last month (+0.8% vs. +0.5%), it’s sixth consecutive gain, led by increases in the stock market (+2.2%) and housing index (+2.2%).
  • US Sales of existing homes rose slightly last month (+3.7% to a seasonally adjusted +5.10m), but prices remain weak. The median sales price for an existing home was $159k, down -5.9% from the revised year-ago median.
  • Canadian retail sales posted its first positive print in both nominal and real terms in February, providing a lift to February GDP growth. Headline retail sales rose at a slightly slower pace than expected in February, up 0.4% m/m versus expectations of a 0.5% m/m gain, while core sales accelerated by 0.7% m/m as auto sales dipped for a third consecutive month.
  • US initial jobless claims fell less than expected last week, remaining above 400,000 for the second consecutive week. Both the extended benefits and emergency unemployment compensation benefits experienced declines.
  • Philly Fed’s Business Outlook Survey plunged from +43.4 to +18.5


  • PBoC hikes reserve requirements another +50bp, for a cumulative +450bp of hikes since the cycle began. Market now expects the PBoC to hike the RRR another +150-250bp and the lending/deposit rates a further +135bp/150bp.
  • NZD has sold off after proving resilient to last week’s carry-trade correction, the catalyst being weaker-than-expected CPI inflation of +0.8%.
  • PBoC governor Zhou stated that China’s central bank FX reserves, which rose about +$200b into +$3trn in the first quarter, had exceeded a reasonable level and may have led to excessive liquidity and had exerted significant sterilization pressure.
  • It’s rumored that the Aussie government is considering tax breaks on foreign sovereign investments in Australia, a good enough reason to want to own the highest yield G10 currency.
  • Australia witnessed a stronger terms-of-trade, where export prices rose +5.2% and import prices rose +1.4%, q/q, pushing the terms-of-trade close to their 2008 and 2010 highs. This will give the RBA a good enough reason to want to raise interest rates (+4.75%).

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Icelandic Kronur: Lessons from a Failed Carry Trade

A little more than two years ago, the Icelandic Kronur was one of the hottest currencies in the world. Thanks to a benchmark interest rate of 18%, the Kronur had particular appeal for carry traders, who worried not about the inherent risks of such a strategy. Shortly thereafter, the Kronur (as well as Iceland’s economy and banking sector) came crashing down, and many traders were wiped out. Now that a couple of years have passed, it’s probably worth reflecting on this turn of events.

At its peak, nominal GDP was a relatively modest $20 Billion, sandwiched between Nepal and Turkmenistan in the global GDP rankings. Its population is only 300,000, its current account has been mired in persistent deficit, and its Central Bank boasts a mere $8 Billion in foreign exchange reserves. That being the case, why did investors flock to Iceland and not Turkmenistan?

The short answer to that question is interest rates. As I said, Iceland’s benchmark interest rate exceeded 18% at its peak. There are plenty of countries that offered similarly high interest rates, but Iceland was somehow perceived as being more stable. While it didn’t apply to join the European Union (its application is still pending) until last year, Iceland has always benefited from its association with Europe in general, and Scandinavia in particular. Thanks to per capita GDP of $38,000 per person, its reputation as a stable, advanced economy was not unwarranted.

On the other hand, Iceland has always struggled with high inflation, which means its interest rates were never very high in real terms. In addition, the deregulation of its financial sector opened the door for its banks to take huge risks with deposits. Basically, depositors â€" many from outside the country â€" parked their savings in Icelandic banks, which turned around and invested the money in high-yield / high-risk ventures. When the credit crisis struck, its banks were quickly wiped out, and the government chose not to follow in the footsteps of other governments and bail them out.

Moreover, it doesn’t look like Iceland will regain its luster any time soon. Its economy has shrunk by 40% over the last two years, and one prominent economist has estimated that it will take 7-10 years for it to fully recover. Unemployment and inflation remain high even though interest rates have been cut to 4.25% â€" a record low. The Kronur has lost 50% of its value against the Dollar and the Euro, the stock market has been decimated, and the recent decision to not remunerate Dutch and British insurance companies that lost money in Iceland’s crash will only serve to further spook foreign investors. In short, while the Kronur will probably recover some of its value over the next few years (aided by the possibility of joining the Euro), it probably won’t find itself on the radar screens of carry traders anytime soon.

In hindsight, Iceland’s economy was an accident waiting to happen, and the global financial crisis only magnified the problem. With Iceland â€" as well as a dozen other currencies and securities â€" investors believed they had found the proverbial free lunch. After all, where else could you earn an 18% by putting money in a savings account? Never mind that inflation was just as high; with the Kronur rising, carry traders felt assured that they would make a tidy profit on any funds deposited in Iceland.

The collapse of the Kronur, however, has shown us that the carry trade is anything but risk-free. In fact, 18% is more than what lenders to Greece and Ireland can expect to earn, which means that it is ultimately a very risky investment. In this case, the 18% that was being paid to depositors were generated by making very risky investments. As the negotiations with the insurance companies have revealed, depositors had nothing protecting them from bank failure, which is ultimately what happened.
Now that the carry trade is making a comeback, it’s probably a good time to take a step back and re-assess the risks of such a strategy. Even if Iceland proves to be an extreme case â€" since most countries won’t let their banks fail â€" traders must still acknowledge the possibility of massive currency depreciation. In other words, even if the deposits themselves are guaranteed, there is an ever-present risk that converting that deposit back into one’s home currency will result in losses. That’s especially true for a currency that is as illiquid as the Kronur (so illiquid that it took me a while to even find a reliable quote!), and is susceptible to liquidity crunches and short squeezes.

When you enter into a carry trade, understand that a spike in volatility could wipe out all of your profits in one session. The only way to minimize your risk is to hedge your exposure.

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Monday, April 18, 2011

A Familiar Game!

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By Mike Conlon | April 18, 2011

The markets are starting the week lower as risk aversion is dominating the action in this holiday-shortened week. In what has become a familiar scene, oil is trading lower as it gets bid up on Friday’s as market participants do not want to go short over the weekend as the risk in the Arab countries is still present.

Adding to risk sentiment are the usual Euro debt crisis rumors, which propose that rate hikes are going to cause Greece and Ireland to default. While this has to be a concern for the ECB, I’m surprised that more clarity isn’t being proffered. Perhaps some Euro weakness in the face of rising rates would be just what the ECB is hoping will happen.

In an attempt to slow down inflation, China raised the reserve requirements for banks again which is intended to curb lending.

Overnight, New Zealand reported CPI data that showed that inflation increased slightly less than expected. In the UK, asking prices for homes came in higher as lack of supply and overall inflation contribute to seller confidence. I guess it doesn’t hurt that London has become the “preferred destination” of former Arab dictators so the market could remain strong for some time.

It will be interesting to see if the US market can shake off the lower start and turn it around by the end of the day. Recently, the US market has seemed immune to negative news and keeps going higher, as Bernanke’s dollar destruction leaves traders few other alternatives.

In the forex market:

Aussie (AUD): The Aussie is mostly lower on risk aversion, but is faring better than the other commodity currencies due largely to its interest rate differential. The minutes from the RBA rate policy meeting are due out tomorrow, which I expect to have a dovish tone as a result of the recent run-up.

Kiwi (NZD): The Kiwi is lower across the board as CPI data came in lower than expected, perhaps dampening hopes of a rate hike any time soon. CPI showed a quarterly increase of .8%, pushing the YoY number to 4.5%, vs. expectations of 1% and 4.6% respectively. (Click chart to enlarge)


Loonie (CAD): The Loonie is also lower as oil has pulled back a day ahead of the release of CPI data. While Canada has not been seeing the inflation that some other regions have, building permits and housing starts figures will show whether or not the economy is moving forward.

Euro (EUR): The Euro is lower against all but the Kiwi as the rumors of a Greek debt restructuring and a possible block of aid to Portugal are making the rounds. PMI data is expected to contract slightly, and PPI data is expected to increase. (Click chart to enlarge)


Pound (GBP): The Pound is mixed under what would be considered a “normal” risk aversion day despite the fact that home asking prices came in higher than expected. The BOE rate policy meeting minutes will be released on Wednesday which could show increased worry over inflation. Retail sales figures come out on Thursday.

Dollar (USD): The Dollar is mostly higher on risk aversion, and Friday markets are closed here in the US. It’s a light week for news in the US, without today bringing some Fedspeak at various locations, and the Philly Fed is due out on Thursday, which could see higher volatility as we have a long market weekend.

Yen (JPY): The Yen is higher across the board on risk aversion as Asian markets were down over night. Trade balance figures are due out on Tuesday night, and I am a little surprised to see Yen continue to strengthen considering the major economic challenges they are facing.

We’ve seen this one before, folks. The markets push both oil prices higher on Friday’s because of the risk in the marketplace and when nothing significant happens, it sells off going into Monday. This helps take markets down (which isn’t a bad thing), and then US stocks tend to rebound to start the week. Rinse and repeat.

Except there is going to be the time when this game does not work, and the selling that starts the day could bring about a “big one”. The markets have been so pumped up on Fed easy-money steroids that sooner or later the bubble is going to burst. What the exact catalyst will be is anyone’s guess but at this point these markets are climbing the “wall of worry.”

In times like these it makes sense to proceed cautiously as no one knows where or when the next risk event may come from.

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UK Growth Expected to Decline

The British economy continues to wrangle with very weak growth even as consumers are being hammered by surging prices. The result is an inflation rate double the target “ideal” of two percent annual inflation. And while the last few years have not been a walk in the park, there appears little prospect for immediate relief.

In a speech delivered in mid December, Charles Bean, Deputy Governor for Monetary Policy and member of the Monetary Policy Committee (MPC), noted that the economy is showing signs of improvement, but cautioned that “it may be some while yet before normality is restored”.

That assessment was made four months ago and one would be hard-pressed to see any progress since then. Indeed, for the first quarter of the year, the situation may have actually worsened.

For four straight quarters in 2010, Gross Domestic Product made positive gains yet for the first quarter of this year, GDP actually fell by 0.5 percent. Despite this, the government still expects growth for the full year to be in the range of 1.7 percent â€" this may prove to be a bit optimistic.

Last week, the International Monetary Fund (IMF) reduced its outlook for the UK from 2 percent growth to 1.7 percent. The Organization for Economic and Development (OECD) cut its position even deeper dropping its earlier 1.7 percent prediction to just 1.5 percent. This makes it unanimous â€" the 2011 perspective for the British economy is actually bleaker now than at the beginning of the year.

Adding to the quandary is that consumer prices are rising at a much faster rate than overall growth. According to Britain’s Office for National Statistics, consumer prices rose another four percent in March following a 4.4 percent increase in February. The resulting inflation is rapidly outpacing gains in salaries and wages and is seriously undermining consumer buying power.

Consumer Price Index â€" Annualized Rate

Nov 2010 â€" 3.2%
Dec 2010 â€" 3.3%
Jan 2011 â€" 4.0%
Feb 2011 â€" 4.4%
Mar 2011 â€" 4.0%

Will Get Worse Before It Gets Better

Like several other developed economies, England faces a huge deficit made worse by the recession’s double whammy of reduced tax revenues and greater expenses arising from monetary stimulus to support the economy. Truth be told however, Britain has struggled with deficits for many years now and the situation has finally reached the point where it can no longer be ignored. Even with higher revenues expected this year, the budget shortfall for the current year is estimated at £140 billion (US$228.5 billion).

In its last budget, the government outlined plans to introduce significant spending cuts to the tune of £83 billion (US$133.5 billion) over the next four years. This is thought to be sufficient to balance the budget assuming higher government revenue as the economy recovers. This also assumes that the spending cuts will not impact those revenues and this is where things tend to get a bit sticky.

For the past six months, Bank of England Governor Mervyn King has argued against hiking interest rates to deal with the mounting inflation. King defends his position by blaming rising food and energy costs for a “temporary” spike in consumer prices suggesting that “core” inflation is actually quite low. King also suggests that as the impact of government’s spending cuts take effect, overall growth could decline even further.

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Where are Exchange Rates Headed? Look at the Data

At this point, it’s cliche to point to the so-called data deluge. While once there was too little data, now there is clearly too much, and that is no less true when it comes to data that is relevant to the forex markets. In theory, all data should be moving in the same direction. Or perhaps another way of expressing that idea would be to say that all data should tell a similar story, only from different angles. In reality, we know that’s not the case, and besides, one can usually engage in the reverse scientific method to find some data to support any hypothesis. If we are serious about finding the truth and not about proving a point, then, the question is: Which data should we be looking at?

I think the quarterly Bank of International Settlements (BIS) report is a good place to start. The report is not only a great-read for data junkies, but also represents a great snapshot of the current financial and economic state of the world. It’s all macro-level data, so there’s no question of topicality. (If anything, one could argue that the scope is too broad, since data is broken down no further than US, UK, EU, and Rest of World). The best part is that all of the raw data has already been organized and packaged, and the output is clearly presented and ready for interpretation.

Anyway, the stock market rally that began in 2010 has showed no signs of slowing down in 2011, with the US firmly leading the rest of the world. As is usually the case, this has corresponded with an outflow of cash from bond markets and a steady rise in long-term interest rates. However, emerging market equity and bond returns have started to flag, and as a result, the flow of capital into emerging markets has reversed after a record 2010. Without delving any deeper, the implication is clear: after 2+ years of weakness, developed world economies are now roaring back, while growth in emerging markets might be slowing.

Economic growth, combined with soaring commodities prices, is already producing inflation. (See my previous post for more on this subject). However, the markets expect that the ECB, BoE, and Fed (in that order) will all raise interest rates over the next two years. As a result, while investors expect inflation to rise over the next decade, they believe it will be contained by tighter monetary policy and moderate around 2-3% in industrialized countries.

The picture for emerging market economies is slightly less optimistic, however. If you accept the BIS’s use of China, India, and Brazil as representative of emerging markets as a whole, rising interest rates will help them avoid hyperinflation, but significant price inflation is still to be expected. I wonder then if the pickup in cross-border lending over this quarter won’t slow down due to expectations of diminishing real returns.

Any sudden optimism in the Dollar and Euro (and the Pound, to a lesser extent) must be tempered, however, by their serious fiscal problems and consequent volatility. As a result of the credit crisis (and pre-existing trends), government debt has risen substantially over the last three years, topping 100% of GDP for the US and 200% of GDP for Japan. Credit default swap rates (which represent the markets’ attempt to gauge the probability of default) have risen across the board. To date, gains have been highest for “fringe” countries, but regression analysis suggests that rates for pillar economies need to rise proportionately to account for the the bigger debt burden. According to a BIS analysis, US and UK banks are very exposed to Eurozone credit risk, which means a default by one of the PIGS would reverberate around the western world.

While I worry that such a basic analysis makes me appear shallow, I stand by this “20,000 foot” approach, with the caveat that it can only be used to make extremely general conclusions. (More specific conclusions naturally demand more specific data analysis!) They are that industrialized currencies (led by the Dollar and perhaps the Euro) might stage a comeback in 2011, due to stronger economic growth and higher interest rates. While GDP growth and interest rates will undoubtedly be higher in emerging markets, investors were extremely aggressive in pricing this in. An adjustment in theoretical models naturally demands a correction in actual emerging market exchange rates!

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Saturday, April 16, 2011

Happy Tax Day!

« Let The Debate Begin! | Home

By Mike Conlon | April 15, 2011

OK, not really. Do you know where your money goes? Well I certainly don’t, and while I am not happy about having to write a big check, at least this means that my trading has been successful. Many Americans are in the same boat, and are disappointed by the lack of stewardship coming from our politicians.

Today the House will vote on the Republican budget plan, but it is DOA in the Senate so let the negotiations begin. Major reform is necessary but very unlikely to take place. I would advocate some sort of polling system, where taxpayers could “allocate” their tax dollars to areas that they feel are important. Take the corrupt politicians out of the equation.

One place where they don’t have to worry budget deficits is China, who reported overnight 9.7% GDP growth. This is an amazing figure considering the state of the global economy, however the reported 5.4% CPI data shows that inflation is still a problem there, which could mean further rate hikes which could potentially slow economic growth for the periphery that depends on Chinese growth. Perhaps it has something to do with the $3 Trillion dollars in currency reserves that China holds, all thanks to their currency peg.

In the Euro zone, Irish debt was downgraded, Greek debt may need to be restructured, and CPI came in a little hotter than expected.

Meanwhile the US Fed continues to deny that inflation exists here in the US, and today’s CPI data will likely prove their point. I guess if the price of things that nobody cares about continues to go down, then it is acceptable to have $4 gasoline. The intellectually dishonesty is sickening frankly.

So stock are set to open lower, and commodities have pulled back some as there is risk aversion to start the day.

In the forex market:

Aussie (AUD): The Aussie is lower as China is the largest importer of Australian raw materials and if the Chinese raise rates to slow inflation than that could affect Aussie exports negatively. (Click chart to enlarge)


Kiwi (NZD): The Kiwi is actually trading mostly higher as the expectation of rate hikes and a higher rate differential after the emergency cuts the RBNZ made to provide relief from the earthquake, may have stoked inflation.

Loonie (CAD): The Loonie is mostly lower as commodities are pulling back on the threat of a potential Chinese slowdown. It has long been rumored that China is the driver behind the recent oil price spike. More US Fed subterfuge if you ask me.

Euro (EUR): The Euro is lower across the board as the Irish debt downgrade and the possible Greek debt restructuring is being the debt crisis back into to focus. Ignoring this won’t make it go away, so some concrete plans could allay market fears, especially if the ECB is going to continue to raise rates.

Pound (GBP): The Pound is also lower as the UK’s close ties to Ireland are helping to weigh on Sterling. With no news out of the UK today, British prospects are looking up when compared to the others.

Dollar (USD): The Dollar is mostly higher on risk aversion and CPI data came in slightly higher than expected, showing inflation at 2.7%. I don’t want to get into the headline vs. core debate, but it is clear that the Fed is intentionally trying to avoid the reality. Stagflation, here we come!

Yen (JPY): The Yen is strengthening as carry-trades are being unwound due to the threat of a potential Chinese slowdown. (Click chart to enlarge)


When both monetary and fiscal policy in a country is deplorable, it makes no sense to invest there. Yes, I am talking about the USA. Politicians can debate the ideology back and forth, but at the end of the day the lack of leadership is truly striking.

Enter the Fed, who will some claim to just be stupid and not malevolent with regard to the way that they do things. In the meantime, hardworking Americans will continue to do their patriotic duty and send in their taxes, so politician/celebrities can fly around on private jets and make policies that nobody wants or needs.

So Happy Tax Day! I hope you are having as much fun as I am!

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!



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Forex Week in Review: April 10-15

This week the dollar had the ‘classic’ opportunity to rally aggressively. Global risk appetite has subsided, commodity currencies have softened and investors were willing to take profit. Instead, we have witnessed only a feeble attempt to rise.

Trichet and company’s hawkishness, mixed with the Fed’s dovish response to higher oil prices continue to make the EUR an increasingly attractive alternative to the dollar. With the Fed expected to now trail all other Cbanks when it comes to tightening, is putting the dollar near the bottom of the G10 carry trade league and up there with the classic funding currencies.

Expect the fears of a debt default and reserve diversification to weigh heavily on the global ‘reserve’ currency. Investors are demanding higher yield to account for that risk and QE2 has done a good job in keeping them artificially low. Asian Cbanks are keen to diversify their dollar denominated reserves into other currencies like the EUR, CAD or other higher yielding currencies.


  • French industrial production was in line with expectations at +0.4%, m/m, while Italian IP was slightly weaker at +1.4% vs. +1.7% consensus. This put the French y/y IP growth rate at a healthy +5.6% in Feb., and combined with last week’s strong German IP number, continues to point to robust industrial momentum in core-Europe. Irish IP, on the other hand, disappointed at -2.4% in Feb.
  • In Norway, CPI fell in Mar. to +1% from +1.2% y/y in Feb. Core-inflation was flat and relatively subdued at +0.8%, y/y.
  • UK CPI inflation was much weaker than the consensus expectation for a flat reading. It fell to +4% y/y in Mar. after rising to twenty-eighth month high of +4.4% in Feb. There was a sharp drop in food inflation, driving down the headline print, but core was also softer and the drop there was broad-based. BoE tightening expectations for the next 12-months has fallen from 75bp to 59bp.
  • BRC data saw UK retail sales fall -3.7%, y/y, in March (largest decline in 16-years). Higher oil prices, VAT and inflation, low wage growth and the prospect of further fiscal policy tightening likely weighed on consumer spending. Combining weaker than expected real economic data and the lack of a convincing hawkish shift from the MPC is pushing a BoE hikes further out the curve.
  • UK employment data again failed to impress. Claimant count rate was unchanged at +4.5% in Mar., with a small increase in jobless claims. Employment rose +143k in the Dec. to Feb quarter after the -69k drop in the Sept to Nov period, dragging the unemployment rate lower to +7.8% from +8%.
  • Press speculation on risks of Greek restructuring has caused European peripheral spreads to widen this week (Portugal, Spain and Ireland), reversing last weeks tightening. German finance minister Schaeuble said that additional steps will be taken if an analysis, expected in June, shows that Greek debt is unsustainable.
  • Ireland’s foreign-and local-currency government bond ratings were cut by two notches to Baa3 from Baa1 by Moody’s
  • Euro area HICP inflation was revised up to +2.7%, y/y, in Mar. from the +2.6% flash estimate. Core-inflation accelerated to +1.3%, y/y, from +1% in Feb. Continued price pressures in the Euro-zone should help reinforce the ECB’s rate hike expectations.


  • US trade gap narrowed in Feb. to -$45.76b, but by less than expected. The underlying details were weaker, as the pace of decline in imports outpaced that of exports.
  • The BoC stood pat on rates this week (+1%). Governor Carney has raised the Bank’s growth forecast for 2011 to +2.9% from +2.4% and predicted that the economy will now return to full capacity in mid-2012, six-months earlier than originally forecasted. The Governor is worried that the currency could weigh on growth and inflation, citing the loonie as a headwind to growth ‘twice’ in his statement.
  • US retail sales just missed expectations (+0.4% vs. +0.5%), but the underlying details were positive. The core-component (ex-autos and energy) posted another decent gain (+0.8%), suggesting that the improvements in the labor force are finally having an affect on consumer spending.
  • The Fed’s Beige Book reported that the US economy continues to expand at a ‘moderate’ pace from mid-Feb through Mar. They indicated that the weak job market was also doing better, with hiring still strong in manufacturing.
  • The BoC’s MPR details show that policy makers expect to gradually hike interest rates through 2013, while warning that the strong CAD could hurt exports and act as a drag on growth, as well as put added downward pressure on inflation through cheaper imports.
  • The number of people filing for US unemployment jumped +27k, w/w, to +412k, closer to the beginning of the year reporting when seasonal volatility impaired readings. Analysts are explaining the unexpected rise away to the effects of adjusting to a new quarter.
  • US producer prices grew at a slower pace in Mar. (+0.7% vs. +1.6%), even the growth in core-producer prices remain relatively subdued at +0.3%, m/m, reducing upward pressure on inflation.
  • Commodity price growth continues to weigh on headline inflation (+0.5%), with both food and fuel prices up further in Mar. Core-inflation (+0.1%) moderated on a monthly basis in Mar., highlighting once again that inflation is contained in the US.
  • Empire manufacturing index extended gains for the fifth straight month in Apr., posting a bigger-than-expected pick-up of +4.2pts to 21.7 (highest level in a year). Proof that that the US industrial sector is regaining momentum, and is supportive of general economic activity.
  • Headline US industrial output bounced back more than expected, up +0.8%, m/m, in Mar. The underlying details suggest broader strength.


  • Chinese imports hit a new all-time high of $152b, broadly matched by exports (just short of a record high). In the 1st Q, the dollar value of exports and imports were up +25% and +33%, y/y.
  • Japanese authorities indicated that they were lifting their assessment of the severity of the nuclear accident from level 5 to level 7.
  • BoK kept its policy rate on hold at +3.00% as expected.
  • PBoC continued to fix USDCNY to a new low each day all week.
  • MAS re-centered their exchange rate policy band upwards maintaining its hawkish stance. The decision should support market expectations of further SGD appreciation.
  • Japanese weekly portfolio flow data showed investors net buyers JPY176bn of foreign bonds and net sellers JPY161bn of foreign equities for net outflows of JPY16.9bn.
  • Strong Chinese growth and inflation numbers have revived concerns over further aggressive tightening by the PBoC. Chinese GDP was a solid +9.7%, y/y, in the 1st Q (consensus +9.4%). Inflationary pressures remain elevated, with CPI inflation rising to +5.4%, y/y, in Mar. from +4.9% in Feb.

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Record Commodities Prices and the Forex Markets

Propelled by economic recovery and the recent Mideast political turmoil, oil prices have firmly shaken off any lingering credit crisis weakness, and are headed towards a record high. Moreover, analysts are warning that due to certain fundamental changes to the global economy, prices will almost certainly remain high for the foreseeable future. The same goes for commodities. Whether directly or indirectly, the implications for forex market will be significant.

First of all, there is a direct impact on trade, and hence on the demand for particular currencies. Norway, Russia, Saudia Arabia, and a dozen other countries are witnessing record capital inflow expanding current account surpluses. If not for the fact that many of these countries peg their currencies to the Dollar and/or seem to suffer from myriad other issues, there currencies would almost surely appreciate. In fact, the Russian Rouble and Norwegian Krona have both begun to rise in recent months. On the other hand, Canada and Australia (and to a lesser extent, New Zealand) are experiencing rising trade deficits, which shows that their is not an automatic relationship between rising commodity prices and commodity currency strength.

Those countries that are net energy importers could experience some weakness in their currencies, as trade balances move against them. In fact, China just recorded its first quarterly trade deficit in seven years. Instead of viewing this in terms of a shift in economic structure, economists need to understand that this is due in no small part to rising raw materials prices. Either way, the People’s Bank of China (PBOC) will probably tighten control over the appreciation of the Chinese Yuan. Meanwhile, the nuclear crisis in Japan is almost certainly going to decrease interest in nuclear power, especially in the short-term. This will cause oil and natural gas prices to rise even further, and magnify the impact on global trade imbalances.

A bigger issue is whether rising commodities prices will spur inflation. With the notable exception of the Fed, all of the world’s Central Banks have now voiced concerns over energy prices. The European Central Bank (ECB), has gone so far as to preemptively raise its benchmark interest rate, even though Eurozone inflation is still quite low. In light of his spectacular failure to anticipate the housing crisis, Fed Chairman Ben Bernanke is being careful not to offer unambiguous views on the impact of high oil prices. Thus, he has warned that it could translate into decreased GDP growth and higher prices for consumers, but he has stopped short of labeling it a serious threat.

On the one hand, the US economy is undergone some significant structural changes since the last energy crisis, which could mitigate the impact of sustained high prices. “The energy intensity of the U.S. economy â€" that is, the energy required to produce $1 of GDP â€" has fallen by 50% since then as manufacturing has moved overseas or become more efficient. Also, the price of natural gas today has stayed low; in the past, oil and gas moved in tandem. And finally, ‘we’re closer to alternative sources of energy for our transportation,’ ” summarized Wharton Finance Professor Jeremy Siegal. From this standpoint, it’s understandable that every $10 increase in the price of oil causes GDP to drop by only .25%.

On the other hand, we’re not talking about a $10 increase in the price of oil, but rather a $50 or even $100 spike. In addition, while industry is not sensitive to high commodity prices, American consumers certainly are. From automobile gasoline to home eating oil to agricultural staples (you know things are bad when thieves are targeting produce!), commodities still represent a big portion of consumer spending. Thus, each 1 cent increase in the price of gas sucks $1 Billion from the economy. “If gas prices increased to $4.50 per gallon for more than two months, it would ‘pose a serious strain on households and could put the entire recovery in jeopardy. Once you get above $5, [there is] probably above a 50% chance that the economy could face a downturn.’ ”

Even if stagflation can be avoided, some degree of inflation seems inevitable. In fact, US CPI is now 2.7%, the highest level in 18 months and rising. It is similarly 2.7% in the Eurozone and Australia, where both Central Banks have started to become more aggressive about tightening monetary policy. In the end, no country will be spared from inflation if commodity prices remain high; the only difference will be one of extent.

Over the near-term, much depends on what happens in the Middle East, since an abatement in political tensions would cause energy prices to ease. Over the medium-term, the focus will be on Central Banks, to see if/how they deal with rising inflation. Will they raise interest rates and withdraw liquidity, or will they wait to act for fear of inhibiting economic recovery? Over the long-term, the pivotal issue is whether economies (especially China) can become less energy intensive or more diversified in their energy consumption.

At the moment, most economies are dangerously exposed, with China and the US topping the list. Russia, Norway, Brazil and a select few others will earn a net benefit from a boom in prices, while most others (notably Australia and Canada) are somewhere in the middle.

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Thursday, April 14, 2011

EUR and Dollar trade on fear

With all the information about the Japanese problems, Chinese monetary tightening, Euro-zone debt debacle has investors confused and/or lacking confidence. It’s no wonder we have these tight non-directional trading ranges with some liquidity vacuum pockets in between. One day data is positive for growth, the next, the MAS is allowing further gains in its currency to combat inflation or the market ponders on Greek debt restructuring worries.

Goldman is going out on a limb again. Earlier this week they suggested lightening up on the one directional lemming commodity positions. Now, its the dollars turn. Despite the currency being undervalued, they believe it will take significant changes ‘to spark a turn around in the buck’s fortune’. They state the obvious, a pick up in job creation, strong foreign demand for US equities and a more aggressive stance from the Fed. They are predicting 1.50 EUR within 12-months.

The US$ is weaker in the O/N trading session. Currently, it is lower against 13 of the 16 most actively traded currencies in an ‘orderly’ session.

Forex heatmap

Yesterday’s US data did not bring forth any real surprises. Even with US retail sales slightly missing expectations (+0.4% vs. +0.5%) the underlying details were positive. The core-component (ex-autos and energy) posted another decent gain (+0.8%), suggesting that the improvements in the labor force are finally having an affect on consumer spending. Analysts note that the gains were relatively broad based with gas station sales up +2.6%, building material +2.2%, electronics +2.1% and furniture +3.6%. It’s worth noting that February’s results were also revised higher to +1.1%.

The Fed’s Beige Book reported that the US economy continues to expand at a ‘moderate’ pace from mid-February through March. They indicated that the weak job market was also doing better, with hiring still strong in manufacturing (this sector continues to lead the gains). It’s worth noting that the higher costs for commodities and raw materials led some companies to raise prices, but, the ability to pass on higher prices varied across regions. With wage pressures subdued, there was little sign of inflation. We get PPI this morning and CPI tomorrow, analysts expect rising manufacturing prices to drive PPI higher, while steady retail prices weigh on CPI growth.

The USD is lower against the EUR +0.21%, GBP +0.44%, CHF +0.36% and JPY +0.69%. The commodity currencies are stronger this morning, CAD +0.10% and AUD +0.18%.

The BoC’s MPR had little effect directly on the loonie yesterday. The details show that policy makers expect to gradually hike interest rates through 2013, while warning that the strong CAD could hurt exports and act as a drag on growth, as well as put added downward pressure on inflation through cheaper imports. Earlier this week, Governor Carney kept rates on hold at +1%. Their new forecast for the loonie is 0.9700.

Overall, the BoC is less concerned about global and US risk as it focuses on the strong dollar. Governor Carney has been trying to talk the CAD down. The BoC statement was less hawkish than it could have been, and suggests the strong potential for policy neutrality for an extended ‘period-of-time’. It’s worth noting that with only 10% of Canadian exports going to emerging markets, Canada is not likely to benefit from the current commodity boom (0.9626).

This month the Aussie dollar has been leading the G10 rally, however, the currency has stalled versus all its major trading partners, especially the yen, in the O/N session after the MAS stepped up its fight against inflation and the BRIC leaders said rising commodity prices posed a threat to growth. The MAS, in its third tightening of policy this year, are combating inflation and their actions appear to be spurring risk-aversion and pressurizing commodity and growth sensitive currencies.

The market weakness in commodities and emerging market equities over the last two trading sessions certainly has not supported growth sensitive currencies. Depending on how risk appetite pans out, these pull backs may end up being a good buying opportunity. With Japan’s loose monetary policy, the yen is expected to continue to weaken further with Japan lagging any significant recovery.

Australian yields are still the highest in the G10 and continue to attract regional investor’s en masse. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on these pullbacks (1.0503).

Crude is little changed in the O/N session ($107.04 -7c). The growing expectation among investors that the Fed will lag other Cbanks in tightening monetary policy is creating a supportive backdrop for commodities, keeping the dollar in check and creating a more favorable investment environment. After solidifying its biggest two-day loss in 14-months, the market found some technical traction, believing this week’s early rout was overdone. Also aiding crude prices was the magnitude of the gasoline drawdown last week, the largest in 13-years.

Last week’s EIA report showed crude stocks climbed +1.60m barrels to +359.3m, remaining above the upper limit of the average range for this time of year. On the flip side, gas supplies plummeted-7m barrels and are near the lower limit of the average range. Oil refinery inputs averaged +14.0m barrels per day during the week, which were-354k barrels per day below the previous week’s average as refineries operated at +81.4% of capacity.

The IEA said it maintains its 2011 global oil demand growth forecast but noted that the high oil prices are beginning to dent demand growth based on its preliminary data for January and February. Both the IEA and IMF have said that prices above the $100 watermark are beginning to hurt the global economy. Even Goldman is recommending to investors to take profit on the one directional commodity trades.

Technically, price movements have been excessive with investors building in a high insurance premium because of the geopolitical situation. The reality is that commodity price shocks have emerged as a new risk to the global economy’s expansion and why the IMF cites the world economy is more likely to disappoint than to beat expectations. However, we have a market condition that was way overbought and in danger of giving up ground with the bears increasing their negative rhetoric.

Gold prices have recovered from their biggest one day drop in a month as the dollar retreats amid expectations that Bernanke and Co. will maintain its accommodative monetary policy in the medium term. Gold as a non-yielding asset has a higher opportunity cost when interest rates rise.

The commodity plunged earlier this week on the back of the reduced economic growth forecasts from the IMF and the easing of inflationary pressures. Goldman indicated that if one owned commodities, the risks outweigh any further potential gain. This had been a catalyst for the bulls to lighten up their long positions. Regardless of event and geopolitical risk, the general dollar malaise against its major G7 trading partners will eventually support commodities. The dollar tends to trade inversely with the price of the commodity. The metal has jumped +27% in the past year.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. Any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store of value ($1,462 +$7.10).

The Nikkei closed at 9,653 up+13. The DAX index in Europe was at 7,145 down-23; the FTSE (UK) currently is 5,975 down-34. The early call for the open of key US indices is lower. The US 10-year eased 4bp yesterday (3.46%) and is little changed in the O/N session.

Treasuries gained as global equities headed lower, increasing investors risk aversion and boosting the demand for the safety of US government debt. Investors are beginning to realizing that the global recovery is not necessarily a ‘one-way move up, but will remain inconsistent’. Rumors of analysts revising US GDP lower (April 28) is also providing some support.

The US government sold $21b in 10-year notes yesterday and will sell $13b in 30-year bonds today. Yesterday’s 10-year auction was not well received, tailing +1.2bp with a yield of 3.494%. The bid-to-cover ratio was 3.13 compared with an average of 3.07 for the previous eight sales. The indirect bid was 42.4% below the 51.2% average.

Expect dealers to cheapen the curve ahead of the long bond issue to take make room for supply.

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Let The Debate Begin!

« Relief At The Pump? | Home

By Mike Conlon | April 14, 2011

Yesterday President Obama came out with a speech regarding the debate that is about to heat up in Washington DC and define the economic course that the US will pursue moving forward. The obvious problem is the US Federal deficit, which is going to bankrupt this country (worse than it already is!) if nothing is done about it.

House Republicans have put forth a comprehensive plan that has both plusses and minuses, and will likely serve as a starting point for negotiations. However, nothing in yesterday’s speech outlined a credible plan to move tackle our problems, so the markets have become fearful of what could happen.

The near-term debate is going to be over what to do about the debt ceiling; if it is not raised or if cut-backs aren’t made, then we could be facing a funding problem. The timing of this essentially coincides with the end of QE2, which has pushed markets higher since its inception at the end of last year.

How the markets will react to both situations is uncertain at this point in time, but the markets are a discounting mechanism so at some point this all needs to be factored in. Perhaps that’s what we’ve been seeing over the last few days of selling.

This morning, both stocks and commodities are lower to start the day as we await the initial jobless claims numbers and the PPI data.

In the forex market:

Aussie (AUD): The Aussie is mostly lower on risk aversion though not by much as it is protected from shorting by its interest rate differential which makes it cost prohibitive to do so.

Kiwi (NZD): The Kiwi moved to a 5-month high after a successful bond auction increased demand for the currency. The Kiwi is tracking slightly higher despite the early risk aversion in the market. (Click chart to enlarge)


Loonie (CAD): The Loonie is mostly lower as its close ties to the US and a declining oil price to start the day have induced selling.

Euro (EUR): There’s no appreciable news out of the Euro zone this morning, so it is trading on its anti-Dollar sentiment which weakened it to start the day though it may reverse as US stocks open. (Click chart to enlarge)


Pound (GBP): The Pound is trading mostly higher after consumer confidence figures came in higher than expected after reaching record lows.

Dollar (USD): The Dollar is mixed as it is receiving the benefit of the flight to safety trade, despite PPI data which just came in at .7% and initial jobless claims that came in higher than expected at 412K. Not a good sign for the economy, but perhaps good for Fed watchers.

Yen (JPY): The Yen is stronger across the board as the Dollar shed some of its safe haven status and the nuclear threat is still a major problem. Yet there are still estimates coming in that predict an economic rebound.

Today’s data in the US shows economic weakness which the Fed is praying may just be an anomaly and a re-start of an economic downturn. The road to stagflation is one the Fed was hoping to avoid, though misguided policies and unintended consequences may be both the cause and the effect.

This bring us back to the fiscal policy debateâ€"if we don’t do something about fiscal policy, then the Fed will attempt to smooth things over with monetary policy. Let’s face it: 100% of the people enjoy a free lunch.

Until we get some real leadership out of Washington DC, we are going to continue to head closer to the cliff at warp speed. I hope you have a parachute!

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

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What’s Next for the Yen?

After the G7 intervened in forex markets last month, the Yen fell dramatically and bearishness spiked in line with my prediction. Over the last week, however, the Yen appears to have bottomed out and is now starting to claw back some its losses. One has to wonder: is the Yen heading back towards record highs or will it peak soon and resume its decline?

Some analysts have ascribed tremendous influence to the G7, since the Yen fell by a whopping 5% following its intervention. From a mathematical standpoint, however, it would be virtually impossible or the G7 to single-handedly depress the Yen. That’s because the Yen holdings of G7 Central Banks are decidedly small. For example, the Fed holds only $14 Billion in Yen-denominated assets (compared to the Bank of Japan’s $800+ Billion in Dollar assets), of which it deployed only $600 million towards the Yen intervention effort. Even if the Bank of Japan is covertly intervened (by printing money and advancing it to other Central Banks), its efforts would still pale in comparison to overall Yen exchanges. Trading in the USD/JPY pair alone accounts for an estimated $570 Billion per day. Thus, given the minuscule amounts in question, it would be unfeasible for the Central Banks alone to move the Yen.

Instead, I think that speculators â€" which were responsible for the Yen’s spike to begin with â€" purposefully decided to stack their chips on the side of the G7. Given the unprecedented nature of the intervention, and the resolute way in which it was carried out, it would certainly seem foolish to bet against it in the short-term.  In fact, the consensus is that, “Investors are confident that the G7 won’t let the yen go below 80 versus the dollar again.” Still, this notion implies that if speculators change their minds and are determined to bet on the Yen, the G7 will be virtually powerless to block their efforts.

For now, speculators lack any reason to bet on the Yen. Aside from the persistent financial uncertainty that has buttressed the Yen since the the 2008 credit crisis, almost all other forces are Yen-negative. First, the crisis in Japan has yet to abate, with this week bringing a fresh aftershock and an upgrading of the seriousness of the nuclear situation. The hit to GDP will be significant, and a chunk of stock market equity has been permanently destroyed.

Thus, foreign institutional interest in Yen assets â€" which initially surged as investors swooped in following the 20% drop in the Nikkei 225 average â€" has probably peaked. The Bank of Japan will probably continue to flood the markets with Yen, and the government of Japan will need to issue a large amount of debt in order to pay for the rebuilding effort. Given Japan’s already weak fiscal situation, it seems unlikely that it can count on foreign sources of funding.

Even worse for the Yen is that Japanese retail traders (which account for 30% of Yen trading) seem to have shifted to betting against it. They are now driving a revival in the carry trade, prompting the Yen to fall to a one-year low against the Euro (helped by the recent ECB rate hike) and a multi-year low against the Australian Dollar. “Data from the Commodity and Futures Trading Commission (CFTC) showed speculators went net short on the yen for the first time in six weeks and by the biggest margin since May 2010 at a net 43,231 contracts in the week to April 5.”

It’s certainly possible that investors will take profits from the the Yen’s fall, and in fact, the recent correction suggests that this is already taking place. However, the markets will almost certainly remain wary of pushing things too far, lest they trigger another G7 intervention. In this way, Yen weakness should become self-fulfilling, since speculators can short with the confidence that another squeeze is unlikely, and simply sit back and collect interest.

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