Wednesday, April 13, 2011

Dollar remains Fools Gold

Despite all the event and geopolitical concerns, there remains a healthy tolerance for risk in the market. Investors believe that the EUR is less exposed to a decline in risk appetite. 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.

The danger to this morning’s US retail sales number, the market is assuming it will disappoint, could increase global risk aversion, contributing to additional carry trade unwind amongst the G10 currencies. This afternoon we have the Fed’s beige book, there, the focus will be on ‘any evidence that US retailers are increasingly willing to pass on higher input prices to the consumers’.

The US$ is mixed in the O/N trading session. Currently, it is higher against 11 of the 16 most actively traded currencies in an ‘whippy’ session.

Forex heatmap

The market preconception is that the divergence of global yields will underpin the value of the dollar, mind you, the weaker data is not helping either. Yesterday’s US trade gap narrowed in February 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 nominal, dollar-based deficit, which includes both price and volume effects, narrowed -1.4%, m/m, to $45.8b in February, as the trade deficit in goods shrunk by -1.6% and the trade surplus in services expanded +1.9%. After five straight months of gains, exports contracted -1.4%. The ‘real’ trade deficit in goods remained virtually unchanged, narrowing -0.1% to $49.5b, its widest level since December. This is what matters to GDP, and carries negative implications for the first quarter.

The USD is lower against the EUR +0.16% and higher against GBP -0.02%, CHF -0.04% and JPY -0.48%. The commodity currencies are stronger this morning, CAD +0.19% and AUD +0.50%.

As expected, the BoC stood pat on rates yesterday (+1%). In his communiqué, Governor Carney 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. Again, he reiterated that the currency could weigh on growth and inflation, citing the loonie as a headwind to growth ‘twice’ in his statement. He repeated the line that a reduction in monetary stimulus would have to be ‘carefully considered’. The market had been expecting it to be replaced with a warning of a reduction in stimulus.

Overall, the BoC is less concerned about global and US risk as it focuses on the strong dollar. Governor Carney is trying to talk the dollar down. The BoC statement followed the trade numbers that are driving the quarterly inflation-adjusted volume-based trade deficit to another record high as export volumes fell -5.2%, m/m, and by more than the -4.3% m/m decline in import volumes.

The statement was less hawkish than it could have been, and suggests the strong potential for policy neutrality for an extended ‘period-of-time’. Softer commodity prices have investors looking to book profits (0.9620).

This month the Aussie has been leading the G10 rally, showing no lasting ill-effects from the decision by the PBoC to hike policy rates last week. Now that the market has been able to digest Japanese event risk and concentrated on global fundamentals has the AUD rising in the O/N session. Signs of global growth is boosting the demand for higher-yielding assets. The currency has snapped a two-day drop versus the yen after industry reports showed Australian consumer confidence rebounded last month (105.3).

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 will provide support for the currency on these pullbacks (1.0484).

Crude is lower in the O/N session ($106.19 -6c). Oil prices collapsed over the last two trading sessions, solidifying its biggest two-day loss in 14-months. 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.

Earlier this week the IMF cut US and Japan’s growth rate forecasts and the IEA reported signs of an oil-demand ‘slowdown’ in its monthly report has the black stuff retreating-6% on the week. Fundamentally, current prices aren’t justified by the supply and demand scenario. 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.

Last week’s EIA report showed crude stocks climbing +2m barrels. The market expected an increase of only +1.3m. On the flip side, gas supplies decreased-400k barrels, while distillates supplies (heating oil and diesel) increased +200k barrels.

The naysayers believe that the recent MENA events will make it unlikely that investors will see a ‘swift normalization’ of crude-oil production in the region. However, we have a market condition that was way overbought and in danger of giving up more ground with the bears increasing their negative rhetoric.

After rallying to another new record this week, gold prices have softened as investors continue to take profit off the table. The commodity slid by more than-1% yesterday, mirroring the sharp decline of other commodity prices and this despite the correlation between the yellow metal and the dollar index reaching it’s most negative in nearly three-months.

The commodity’s downfall has been sparked by 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 has 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 ($1,457 +$4.30).

The Nikkei closed at 9,641 up+86. The DAX index in Europe was at 7,145 up+42; the FTSE (UK) currently is 6,006 up+42. The early call for the open of key US indices is higher. The US 10-year eased 7bp yesterday (3.50%) and is little changed in the O/N session.

Treasuries gained for the first time in three days after a nuclear warning and earthquakes in Japan sent global equities 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’.

The US government will sell $21b in 10-year notes today and $13b in 30-year bonds tomorrow. Yesterday’s $32b 3-year issue was well received, stopping at +0.6bp through the screens at +1.28%. Indirect bidders took +33.7% of the issue, direct took +8.9% compared to an average of +13.9%. The auction had a 3.25 bid-to-cover ratio compared to an average cover of 3.07.

Expect dealers to cheapen the curve ahead of the issue to take down supply.

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