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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