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By Mike Conlon | March 4, 2011

All eyes this morning are on the US Non-Farm Payrolls (NFP) report due out at 8:30AM EST. While this is always one of the most significant economic reports that will induce market volatility, it hasn’t been this anticipated for some time.

Last month’s NFP report was an outlier, in that the 36K jobs gains reported almost came with a notion of disbelief, as if it was a mistake of some sort. Bad weather was blamed for the disconnect; but the figure showed that only 36K jobs were created, yet the unemployment rate fell from 9.4% to 9%. As I said in last month’s NFP blog article, you can’t have the BLS without the BS!

So this month we are expecting there to be gains of 196K jobs, with the unemployment rate ticking slightly higher to 9.1%. Recent data of late has been better than expected, especially when considering that the ADP employment change showed better than expected gains on Wednesday, and initial jobless claims came in lower than expected on Thursday. “Only” 368K people lost jobs last week, beating the expectation of 395K losses.

So this number should be pretty good today then, right? I’m not so sure. As I mentioned last month, when everyone gets their hopes up so high for good numbers, they usually end up disappointed. There is no other news to rely on today, so this number will be critical.

Last month I offered a guess as to what the number would be, and will my prediction was correct that it was worse than expected, I couldn’t imagine how much worse it was. This month I think we may see more of the same. So my prediction (remember this is a guess and NOT a trade recommendation) is that we will see jobs gains of 112K, better than last month but missing expectations. I think this will somehow induce US dollar strength today, as the Dollar seems very oversold to me. Regardless of what happens, there will be major volatility as the market digests the data.

Speaking of volatility, who saw the crazy move on the Euro yesterday? It happened right around 8:30 and the talking heads tried to attribute it to the initial jobless claims numbers, but basically ECB head Trichet said that he could raise rates next month, sending the Euro higher to the tune of 150 pips. This also helped risk-taking as US stocks made tremendous gains.

Stocks and commodities are higher to start the morning, but will these gains continue? Stay tuned for NFP!

In the forex market:

Aussie (AUD): The Aussie is mostly lower this morning as Prime Minister Gillard said that Aussie strength “puts burdens” on some areas of the economy. In addition, a separate report cited Australia’s housing market as being in a tremendous bubble which could pose a risk to the economy.

Kiwi (NZD): The Kiwi is also lower as the International Monetary Fund (IMF) said it will likely cut it forecast of New Zealand’s growth as a result of the two earthquakes. The rate expectations for New Zealand actually show that a reduction may be coming before another hike. The Kiwi has had a tough week. (Click char to enlarge)

Loonie (CAD): The Loonie is mixed this morning as the tug of war between higher oil prices and Canada’s economic ties to the US battle for position.

Euro (EUR): Wow, what a move for the Euro yesterday. The ECB finally did issue the hawkish comments the market was waiting for, after about 45 minutes of hemming and hawing. Was that a timed announcement with US economic data at exactly 8:30AM? Let the conspiracy chatter begin! (Click chart to enlarge)

Pound (GBP): The Pound is mostly higher as rate expectations shrug off recent home price data that has showed declines.

Dollar (USD): The Dollar is actually trading higher this morning as despite the mild risk taking in the market: This “wait and see” approach should provide trading opportunities on the release of the NFP report.

Yen (JPY): The Yen is weaker across the board as it is still trading under expected risk themes.

Put up or shut up! There are no more excuses! The US needs to see jobs growth and today’s number will be critical. There are two competing arguments for the direction of the Dollar today.

The first argument says that if the number should come in better than expected, then the Dollar should rally higher as this means that the US economy is improving and Bernanke will have to move on rates sooner to combat inflation. If the number is worse, than it justifies his position of fragile recovery and the need for a weak Dollar.

The alternate argument is that a better than expected number while good for the economy, will cause Dollar weakness as Bernanke has been blind to the inflation story and will not pre-empt QE2 under any circumstance. This comes as just about everyone else around the globe is complaining about inflation.

I’m actually in the second the camp, but think that a worse than expected number will cause Dollar strength today (the opposite of the scenario I laid out above). However, I will not be taking positions before the release, as I always prefer to let the market tell me which way to go.

So I can envision a scenario where the number comes in worse than expected (see my guess above) and initially the Dollar trades lower, but then quickly rebounds and finishes the day higher. This feels like a “crescendo moment”, with a sharp price spike and major volatility to reverse recent Dollar weakness.

At least that’s what I hope will happen, otherwise the Dollar may be falling off of a cliff! See you at 8:30!

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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Week in Review-March 4th

The EUR continues to outperform the dollar as investors interpret the ECB’s view to oil price shocks as inflationary events requiring a tighter monetary policy, in contrast to the Fed and the BOE, who are focusing on the deflationary impact. Trichet has followed in the hawkish footsteps of his coworkers and plied the EUR with enough ammo to dominate the non-inflationary Bernanke effect. The ECB will take the fight to inflation, maybe as early as next month. With the Libyan situation showing little signs of improvement and with the sovereigns continuing to weigh on the dollar, safe heaven trading strategies are the only option in this current environment. Below, we have some of the highlights of the week.

EUROPE

• Fine Gael wins Irish election and is in coalition talks with Labour. Victory will give them a clear mandate to try to renegotiate its EU/IMF bailout package.

• Euro area January CPI was revised down to + 2.3%, y/y from flash estimate. Core-CPI was also a tenth below consensus. Market continues to see elevated risks of a hawkish shift from the ECB.

• Euro manufacturing PMI’s continued to surprise to the upside, with particular strength in Ireland and Italy, driven by the forward looking components. Greece remained the weak spot amongst the periphery. Euro area was left unchanged at 59.

• Swiss PMI and 4th Q GDP showed surprised strength. GDP grew +0.9%, q/q, while the PMI bounced to 63.5 (highest level in six-months). Strong external demand from Germany and Asia is pulling the economy along despite CHF overvaluation. No hawkish rhetoric is expected at this months SNB meeting.

• UK PMI was flat last month, 61.5. New orders moderated, but employment hit a fresh high of 61.7 from 59. The 2011 releases show a solid recovery in the UK manufacturing sector in 1st Q and supports the hawkish camp at the MPC. King continues to send distinctly dovish signals that ‘raising rates to make a gesture is self defeating’. Market is pricing a hike in May.

• UK services PMI fell to 52.6 from 54.5, m/m. Analysts view the softness as more of a technical reversion to trend after the weather-induced volatility in December and January.

• Euro-zone registered strong increases in services (56.8) and composite PMI’s (58.2) for February, but below the preliminary estimates. Strong services gains were driven by France and Italy. The peripheries saw substantial gains in Ireland and Spain. Services PMI’s coupled with the firm manufacturing PMI’s point to robust growth in the Euro region.

Americas

• US consumers are hoarding their stimulus. Consumer spending disappointed with a +0.2% gain. Offsetting this disappointment is income jumping +1%, more than double the expected pace.

• Strong proof for the US housing markets weakness was pending home sales falling for a second consecutive month in January (-2.8% to 88.9). Even the revisions went deeper, with December falling into negative territory (-3.2%) from its original positive print (+2%).

• February’s Chicago PMI print of 71.2 was the highest reading in 23-years, led by a surge in production to 78.2 from 73.7. This release is hot on the heels from the January ISM manufacturing index, and the Empire and Philly Fed surveys for February and providing more proof that manufacturing is picking up in the 1st Q, in part on a need to build inventories.

• Surprisingly strong Canadian 4th Q GDP of +3.3% vs. +3% expected and an upward revision to the 3rd Q print to +1.8% from +1% pushed the loonie to new three years high outright.

• US January ISM numbers expanded at its fastest pace in seven-years (61.4 vs. 60.8), as factories added workers and pumped up production, continuing the momentum for their expansion.

• US construction spending fell for a second-consecutive month in January (-0.7% vs. -1.6%). Builders have had trouble getting finance and even with the tighter credit conditions, demand for credit in some places remains weak.

• Bernanke will not be tightening monetary policy until he is more confident that US recovery can stand on its own. ‘Once we see the economy is in a self sustaining recovery and employment is beginning to improve and labor markets are improving and inflation is stable and approaching +2% or so….at that point we will begin withdrawing’. That being said, he is aware of the risk that the Fed will act too slowly and allow inflation to get controlled.

• The BoC held rates steady at +1%. Governor Carney expressed his concern about the strength of the loonie ‘the export sector continues to face considerable challenges from the effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance’. The new reality is a Canadian dollar at or close to parity as the economy adjusts to this paradigm.

• ADP Private Payrolls rose +217k last month, up from a revised +189k.

• Fed’s Beige Book suggests that overall ‘economic activity continued to expand at a modest to moderate pace in January and early February’ and that price pressures are increasing. All the districts recorded ‘solid’ growth in manufacturing and retail sales increased in all districts.

• US weekly claims fell by -20k to +368k, the lowest level in nearly two-years. The less volatile four-week-moving-average now stands at +388k.

• US ISM non-manufacturing was not much of a surprise, coming in at 59.7 last month, just above market expectations. However, it’s the strongest reading since August 2005. The headline print is proof that the service growth appears to be finally entering a ‘self-sustaining’ pattern.

• US job market rebounded last month, unemployment rate fell to 8.9%, lowest level in two-years. NFP rose +192k as private sector added +222k new jobs. The January number was revised to show an increase of +63k from a previous estimate of +36k. The Fed still expects unemployment to range from +7.5% to +8% at the end of 2012 as the economy only slowly regains the 8.75m jobs lost.

• US January factory orders reported a strong +3.1% increase. The mixed data (strong non-durables and weak durables) remains consistent with strength in the above manufacturing surveys.

• Canadian Ivey PMY continues to express extreme volatility rising to 69.3 last month from 41.4 in January. The correlation between PMI and total remains weak. Market perhaps should be looking at a six-month average.

ASIA

• NZD Confidence rose to 34.5 last month â€" a seven-month high â€" from 29.5 in January.

• Japan industrial output rose a weaker-than-expected +2.4%, m/m (+4% expected). Retail sales (seasonally adjusted) rose +4.1%, m/m, vs. +2.7%. Manufacturing PMI rose for the fourth-consecutive month to 52.9 in February, with the new orders and export orders again rising significantly. JPY remains very much a play on the US rate outlook and risk aversion trading strategies.

• Chinese PMI data provided little excitement and little new information. Headline was in line with expectations at 52.2 in January. Analysts are calling for growth moderation and do not expect a change in monetary policy from Beijing any time soon.

• Dovish comments from New Zealand’s PM Key this week. He said that a RBNZ rate cut priced in by markets for March was in line with his expectations given the economic impact of the recent Christchurch earthquake. Market is pricing a 25bp RBNZ cut on the 10th March.

• Australian 4th Q GDP was weaker than expected +2.7%, y/y vs. +2.8%. The data still point to higher policy rates and AUD appreciation medium term. Analysts continue to anticipate a strong positive uplift this quarter despite severe flooding and cyclones. The RBA noted that mildly restrictive rates are appropriate. Do not expect them to get too far ahead of the RBNZ.

• Australia reported a -15.9%, m/m, fall in building approvals in January. Market continues to look beyond January data severely impacted by the floods.

• China’s non-manufacturing PMI fell to 44.1 last month from 56.4 and inline with seasonal patterns. The PBoC hiking 1-year lending, deposit rates +25bp and reserve requirement +50bp in February has also weighed on consumer sentiment.

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Oil Prices and the FX Conundrum

I haven’t blogged about oil prices in quite some time. After prices collapsed in the wake of the financial crisis, there really wasn’t much to talk about. However, the price of crude oil has risen more than 50% since June, and it now seems to be at the forefront of investor consciousness. Currency market watchers, in particular, need to brace themselves for the nuanced and sometimes contradictory ways in which oil prices bear on exchange rates.

Under normal conditions, the impact of rising oil prices on the currency markets is somewhat straightforward. First of all, the currencies of oil-exporting countries will typically experience some degree of appreciation. In addition, since oil contracts are still mainly settled in US Dollars, oil prices and a weak Dollar tend to go hand-in-hand. Second, insofar as rising prices drive inflation, the same can be said for Central Banks that are proactive in tightening monetary policy. As real interest rate differentials widen, (risk-averse) capital will naturally gravitate towards the highest returns.

The same logic cannot be applied to the current situation, however. That’s because this time around, oil prices aren’t being driven by economic fundamentals and rising demand, but rather by concerns over supply. You don’t have to be an expert to understand the connection between the continuing Mid East political crisis and oil futures. In the last two weeks alone, prices have risen a whopping 15% and show no sign of abating, as long as tensions linger unresolved.

From that standpoint, you might expect the political tensions to drive safe haven flows to the US Dollar. On the other hand, you would also expect that the resulting high oil prices might crimp the US economic recovery, and cause traders to punish the Dollar. However, you also need to consider that rising oil prices might also cause the Fed to eventually raise interest rates, or at least rein in QE2, which would be Dollar-positive.

Enough with the theory; let’s look at what’s happening in reality! The Canadian Dollar and Australian Dollar are rising, even though oil accounts for only 7% of the  former’s exports, and is a nil factor in the latter’s economy. It looks like forex investors are confusing oil prices with commodity prices, which are also rising, but at a much slower pace. In addition, since higher energy prices will probably erode economic growth in energy importing countries, this could actually hurt some commodity currencies over the long run.

The US Dollar has fallen across-the-board. While Ben Bernanke has insisted that the impact of higher energy prices on the US economy will be minimal, the markets are either taking the opposite view or are punishing the Dollar for the Fed’s dovishness. In other words, if Bernanke isn’t concerned about oil, he probably won’t cap QE2, and certainly won’t steer any interest rate hikes in the near-term.

Meanwhile, the European Central Bank (ECB), whose mandate is tilted towards maintaining price stability, has begun to voice concerns about the impact of rising commodity prices on inflation. Consumer and producer price indexes are rising across the Eurozone, and members of the ECB have suggested that they will take a proactive stance in preventing them from spurring inflation.

In conclusion, while both the EU and the US are net oil importers, the Euro is poised to outperform the Dollar, all else being equal. In addition, as long as the mid east political protests don’t drive further instability and contribute to any major supply shocks (especially in Saudi Arabia and Iran), there won’t be any impetus towards safe-haven capital flows. At the same time, while I don’t pretend to be an expert on oil prices, I would expect prices to stabilize and for a handful of minor corrections to materialize in the fx market. Traders are still looking for an excuse to short the Dollar in favor of, well, everything else, but sooner or later they will have to accept the limits of this trade, high oil prices or not.

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NY Traders Expo!

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By Mike Conlon | February 18, 2011

It’s that time of the year again folks! 

Join FX EDU at booth # 5613 for The New York Traders Expo on February 20-23, 2011 at the Marriott Marquis Hotel. This is the ultimate opportunity to meet face-to-face with industry leaders.  FXEDU will be conducting numerous tutorials on trading and trade strategies throughout the expo and will be offering unbelievable discounts on our courses, in addition to giving away thousands of dollars worth of prizes to those who stop by.  Test out the hottest products and software, and learn techniques you can use now that will minimize your risk and increase your profits. Every speaker at The Traders Expo is carefully selected because of his or her proven ability to teach trading techniques that can lead to a lifetime of success. Register now and prepare for four days that will get you on track for a profitable future! Call 800/970-4355 and mention priority code 021879 or register online. 

In addition, come see me give a talk on the reasons that you need to be in the forex market and how you can become a better trader in under 30 minutes/day. My workshop, “Trade Forex Like a Professional in 30 Minutes or Less a Day”, will be given on Monday, February 21st at 3:30PM.  You can view the event details here. 

So I hope to see you all at this amazing event, which will feature some of the best minds in the business and show you the cutting-edge in trading today. I hope to see you there!!! 

For those of you who can’t attend, please check out our currency trading courses! 

If you wish to get started in the forex market, click here.  Don’t miss out on the world’s fastest growing market!

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Week in Review-Feb 18th

Risk-sensitive currencies are surviving despite a China reserve requirement ratio hike and confirmation from Egyptian authorities that Iran had formally requested permission to transit the Suez Canal. ECB board member Bini Smaghi comments that the Central Bank will have to watch inflation closely has the ‘bullish hawks’ squeezing the weak EUR bears positions. Investors, in these thin markets are again adding some geopolitical and G20 risk premium to their portfolios. The most logical reason for not wanting the dollar, despite the US inflation components edging higher this week, is the belief that an ambivalent Fed is falling behind the curve. The lack of confidence in the US administration’s ability to deal with its issues has investors questioning owning the reserve currency. Below, we have some of the highlights of the week.

EUROPE

• Euro-zone Industrial production fell -0.1%, m/m, in Dec. after rising a revised +1.4% in November. The market was seeking a flat reading. IP was flat in Germany and up +3.8% in Portugal, but weaker in Spain (-0.8%) and Ireland (-1.7%). Analysts believe the weather suppressed production in Germany. However, the softness in Spanish and Irish numbers again promotes further EUR negative sentiment.

• The Euro-group finance ministers met to discuss peripheral financing issues and again did not agree on specific measures. The principal innovation from the meeting was agreement of the size of a future (post-2013) backup facility at EUR 500bn, supplemented by an IMF contribution. No specifics on the mechanics or financing of this facility or clarification on measures to enhance the pre-2013 EFSF. These details will need to wait until March summits, creating risk for peripheral sentiment.

• News of complications in the restructuring plans of German’s West Lb again heightened Europe’s financial sector concerns.

• Euro flash GDP came in weaker than expected, rising just +0.3%, q/q vs. a +0.4% consensus. National releases so far across Europe showed a still weak recovery in the periphery, as Portuguese GDP contracted in 4th Q, while the Greek economy showed little sign of improvement. In core Europe, German and French GDP growth was softer in the 4th Q due to adverse weather. However, y/y, German GDP still grew a robust 4%.

• The ZEW survey in Germany showed strength in the current economic assessment but weaker than expected forward sentiment in February. Next week’s Ifo will give the market a clearer picture of German momentum into March.

• UK January inflation was +4.0%, y/y, softer than market fears of +4.3%. However, Governor King’s letter to Chancellor Osborne explaining the inflation overshoot of target contained two surprisingly hawkish twists. Inflation will be ‘as likely to be above the target as below it two to three years ahead’ based on market assumptions for the Bank Rate to rise. King also noted that the split in the committee and said that ‘every member of the Committee is determined to act to adjust policy in order to bring the (inflation) risks into balance’. Market is trying to price in a rate hike by May or if not sooner. The inflation report is making it difficult.

• Surprisingly in the inflation report, BOE pushed its GDP trajectory a bit lower, kept the central projection for inflation in two years’ time under the 2% target, assuming market rates at just 2%, and also assuming that the Bank Rate remains unchanged. This would suggest that King would need to see a significant tightening in the UK labor market and signs of labor regaining pricing power over wages before turning ‘hawkish’.

• UK Jobless claims unexpectedly climbed +2.4k last month vs. an expected -3k decline. Growth in average weekly earnings also slowed to +1.8% in Dec. from +2.1% previously.

• UK CBI export orders rose to the highest level since July 1995. The CBI headline improved to -8 in February from -16 last month. The forward looking output expectations component strengthened to 23, the third consecutive monthly gain. This should point to another strong PMI release in February, as our economist noted, and supports the notion that the benefits from a weak GBP are starting to kick in.

• UK retail sales rebounded sharply last month and although Dec. saw a big downward revision. UK core sales advanced +1.6%, m/m (the biggest in a year), however, Dec. sales was revised lower from -0.3% to -1%, m/m. In nominal terms, sales are up +5.3%, y/y (highest rate since May 2008). This will support the hawks on the MPC.

• Chancellor Merkel nominated her economic advisor Jens Weidmann for President of the German Bundesbank

• ECB board member Bini Smaghi said that the Central Bank will have to watch inflation closely to keep rising costs in check. The market has interpreted the comments to signal that the ECB is again looking towards a possible interest rate hike to combat inflation in the coming months.

• Today and tomorrow will see France hosts the finance ministers and heads of the central banks of the G20 bloc. The ministers will follow up on the pledges made by the leaders at in Seoul in November, particularly regarding exchange rates. The market can expect a communiqué on Saturday. The meeting will discuss global imbalances. There may be agreement on the need for better monitoring of current-account deficits and surpluses.

Americas

• Headline (+0.3% vs. +0.5%) and core-US retail sales (+0.3% +0.5%) continue to rise but disappointed the aggressive upbeat expectations. Analysts are questioning the price versus volume effects in calculating the market disappointment. There is talk about a downward revision to 4th Q GDP. The backward revisions certainly took some of the steam out of the Jan report. Both the headline and core were revised lower in December and it was just the core print adjusted for the November release.

• US import prices accelerated higher last month, doubling to +1.5%, higher than market expectations. This is the fourth consecutive month of price increases (4-month annualized rate more than +15%). These numbers will have the Fed being challenged on its price stability policy. Year-over-year, import prices are up +5.3%, while export prices are +6.8% higher. Obviously, export prices got a boost from the Fed’s QE2 stance.

• Manufacturing in the NY region grew at its fastest pace in eight-months (+11.92 to +15.43). Analysts note that with capacity utilization at historical lows, there remains plenty of room for manufacturing to aid consumer consumption in the economic recovery. It’s worth noting that the Empire index has been relatively consistent over the past year. Analysts are optimistic that business will begin open their coffers and spend more of their cash hoards on capital goods.

• The FOMC minutes did not sway from recent market opinion. The improved economic views were not enough to change the outlook very much. Near term growth, unemployment and prices all improved, but this strength does not seem to be carried through to the longer term view. We have witnessed the split on the speakers circuit of late, however, consensus does not need to change policy just yet. Some members felt that ‘if more data showed stronger evidence of recovery it could justify changing the pace and size of current asset purchases’.

• US Jan. housing starts advanced +14.6% to +596k. The aggressive rise easily offset the softer permits surprise of -10.4% declines to +562k. Analysts note that even with the abnormal weather variable and regulatory changes, the print looks ‘consistent with a moderate underlying improvement’. Noting that mortgage rates continue to tick higher, the overall picture though somewhat upbeat will definitely not be leading US economic recovery any time soon.

• US producer prices advanced for a seventh consecutive month in January (+0.8%). It’s not surprising to see that most of the support came from energy prices (+1.8%). The stronger than expected core-PPI reading (+0.5% vs. +0.2%), coupled with stronger data of late, is expected to eventually put pressure on the Fed’s doves to abandon any plans of further monetary accommodation, like QE3. The market is beginning to expect the debate over monetary policy to ‘return to more normal lines’ in the second half of this year.

• US industrial production disappointed, declining -0.1% vs. a market expected rise of +0.5%. The surprise is palatable because of December’s upward revision from +0.4% to +1.2%.

• Canadian December manufacturing data recorded a big miss (+0.4% vs. +2.3%), however the impact was eased by the modest positive prints on capital inflow (+9.63b) and leading indicator data (+0.3%).

• US inflation (headline CPI +0.4%) is still being bullied by gas prices. Strip transportation (+0.23%) and the gas component out of the report, and we have inflation going nowhere in the US economy (core-CPI +0.2%). It’s not generalized inflation, but, price shock being expressed mostly by commodities.

• The US jobless claims headline (+410k) happened to give back some of the previous week’s gains. Initial jobless claims increased by +25k. Apart from last week’s +385k print, it is the second lowest level seen this year. The less volatile four-week moving average moved a touch higher to +417.8k and remains supportive of a firmer NFP report for this month.

• The Philly Fed print blew everyone out of the water (35.9 vs. 19.3). This is strong proof that ISM may not have peaked. The strength can be attributed to a surge in shipments and higher prices. The gain in shipments is on the back of a solid quarter of new-orders.

• Canadian Wholesale trade (+0.8%) is expected to add to December’s GDP print, while housing starts, hours worked and manufacturing sales will act as a drag. It is the fifth-consecutive month of gains and came with a significant price effect.

• Canadian inflation disappointed the medium term hawks. In non-seasonally adjusted m/m terms, headline CPI advanced +0.3%, while core remained flat. In a seasonally adjusted m/m terms, headline CPI was up a more modest +0.2%, and +0.1% at the core level. The absence of inflation pressures combined with a mixed growth picture should keep the BoC on hold until late this year.

ASIA

• Japanese GDP contracted only -0.3% in the 4th Q vs. market expectations of -0.5%. This was largely due to 3rd Q revision to +0.8% from +1.1%, q/q. With yields so low, the JPY will remain vulnerable as other G10 countries begin to tighten.

• Value of loans in Australian managed to advance +2.5% in Dec. Home loans increased +2.1%, m/m, doubling the +1.0% forecasted. Investment lending was up +3.0%, offsetting the revised -2.0% contraction in Nov.

• Chinese Jan. trade surplus was +$6.5b (smallest surplus in nine-months). The 12-month rolling surplus fell back to $177b from $185b in Dec. The narrowing surplus was due to record high imports of $144b, up +51.4%, y/y. Exports were up +38%, y/y, to $151b. Strong proof that Chinese demand remains solid.

• The recalibration of the Chinese inflation release (+4.9% vs. +5.3%) is having only a modest affect on risk and Asian currencies. The lower than expected, but elevated print is proof that rising food, housing inflation, will keep headline inflation elevated and require Chinese policy tightening to be front-loaded. This is obviously a risk to domestic growth, handcuffing the PBOC in being more hawkish on their exchange rate policy.

• RBA minutes stated that a ‘slightly restrictive’ policy stance was appropriate as a resources boom boosts incomes. The minutes offered no new real news, but stated clearly that the medium-term outlook for the Australian economy remains robust.

• The NZ PMI rose +0.6% to +53.7 in Jan. Input prices rose +0.9%, q/q, while output prices only rose +0.2%, with producers not passing on costs in full. The ANZ consumer confidence fell -9% to 108.1 in Feb.

• China raised reserve requirements by 50bp, accelerating its pace of tightening (+19.5%). The markets appear to be getting more comfortable with the notion that the PBOC can achieve a soft landing without disrupting global markets.

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The Obama Budget and the Dollar

Last week, the Obama Administration released its fiscal 2012 budget to much fanfare. Unfortunately, the budget makes only a token effort to address the rising National debt, and forecasts a budget deficit of $1.1 Trillion. While the release of the budget failed to make a splash in currency markets, traders would be wise to understand its implications for the future.

The budget proposes spending of $3.7 Trillion in 2012, and forecasts receipts of only $2.6 Trillion. As usual, entitlements (Social Security, Medicare, and Medicaid: $2 Trillion+), Defense ($760 Billion), and net interest on debt ($250 Billion) are projected to consume the brunt of spending. The Departments of State, Education, Energy, and Veterans Fairs will receive an increased allocation, while almost all other Departments face drastic cuts. (For more comprehensive breakdowns, the WSJ and NY Times offer excellent graphical representations of how the federal budget is funded and disbursed).

The proposed budget allows for a deficit of $1.1 Trillion (7% of GDP), which unbelievably represents a significant decrease from the $1.6 Trillion (11% of GDP) that is projected for fiscal 2011. The Congressional Budget Office (CBO) forecasts the deficit to return to a more “sustainable” level of 3% of GDP beginning in 2014, which should allow the national debt to remain constant in relative terms for the following decade. Beginning in 2021, however, entitlement spending is projected to skyrocket, which would cause debt to rise similarly.

CBO projections are based on a handful of rosy assumptions. First of all, it assumes that the US economy will grow at 3%+ for the indefinite future. Second, it assumes that deficit spending can be financed at reasonable interest rates. Third, it assumes that tax receipts will rise from current lows and revert back to historical levels. Given the ongoing economic uncertainty, high unemployment rates, tax cuts, rising interest rates, the difficulty of cutting spending, etc., there is reason to believe that actual deficits will be even higher.

In fact, net interest payments on national debt will rise 33% over the next year even as Treasury rates remain at record lows. If the economic recovery gathers momentum (something that the budget is counting on), risk appetite and interest rates must rise. In addition, given that the national debt will probably double from 2009 to 2012, it seems likely that investors will demand an increased risk premium for lending to the US. On the other hand, demand for Treasury Securities continues to remain strong: “Net long-term securities transactions showed total buying of $65.9 billion in long-term U.S. securities in December, after purchases of $85.1 billion the month before.” Many Central Banks continue to be net buyers.

In addition, there are some commentators that think the Fed will abet the US government in deflating the real value of its debt. Since the majority of US Treasury Securities are not inflation-protected, 15 years of high inflation (~5%) would be enough to decrease the real debt burden by half. Especially when you account for “contingent obligations,” this might be the only feasible way for the government to deal with its debt burden over the long-term. Then again, higher inflation would probably drive proportional increases in yield, such that the Treasury Department would have a tough time rolling over existing debt (let alone in issuing new debt) at reasonable interest rates.

The main variable in all of this is politics. Specifically, this budget is still only a proposal. The actual budget won’t be ratified for at least another six months, and only after tense negotiations with the Republican Party. (There is also the possibility that it won’t be passed at all, which is what happened with the fiscal 2011 budget). “House Majority Leader Eric Cantor, a Virginia Republican, said his party will propose ‘very bold’ changes to entitlements in their 2012 budget resolution.” Anything short of this wouldn’t dent the projected deficits and would push Social Security / Medicare closer towards the brink of insolvency.

In the end, the deficit merely represents business as usual for the US government. Barring a double-dip recession, it probably won’t be enough to seriously impact the Dollar’s status in the short-term as preeminent global reserve currency. However, that could start to change over the next decade, as the government either takes steps or does nothing to mitigate the looming entitlements crisis. At that time, the long-term viability of the Dollar (and the financial system as we know it) will become clear.

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Falling On Deaf Ears!

« The Storm Ahead? | Home

By Mike Conlon | February 17, 2011

At least that’s what appears to be going on here in the US, as yesterday’s PPI figures showed rising prices ahead of today’s all-important CPI report. Yet the minutes from the FOMC meeting told an entirely different story.

Bernanke and the Fed remain committed to the idea that either rising inflation is unimportant or that it is not taking place at all! So this is either a case of complete incompetence or intellectual dishonesty. Either way, the picture is not pretty.

Meanwhile, politicians in Washington are arguing over the proposed government budget yet no one is willing to tackle the major problems that affect the deficit so extend and pretend continues. Perhaps Bernanke and the Fed are aware of this so they continue to enable bad behavior rather than forcing politicians to make hard choices.

Today’s CPI report will show where inflation is “officially”, but I expect some sort of major disconnect that will leave the market scratching its head. Much like this month’s ubiquitous Non-Farm Payrolls report, I expect this figure to be an outlier.

I’ve been harping on the UK as of late and apparently someone over there has taken notice. Well not exactly, but the lone dissenter at the BOE came out and said that higher rates and a stronger Pound might actually be GOOD for the UK economy. Thus the Pound is slightly higher. Maybe Andrew Sentence is a closet reader of forex trading blog!

Lastly, it looks like news out of the Middle East is showing that unrest is spreading to various regimes, and a story yesterday about Iranian warships sent oil higher. There is still a good deal of event risk coming from that region of the world, and I’m not certain that the global financial markets are respecting the potential impact.

So markets are mostly flat this morning, waiting on the US CPI data which is expected to show inflation of 1.6%.

In the forex market:

Aussie (AUD): The Aussie is slightly higher this morning after stocks were higher in the Pac Rim markets. There is a slight bias toward risk-taking ahead of today’s CPI data.

Kiwi (NZD): The Kiwi is also higher slightly higher even though consumer confidence figures came in lower overnight. In addition, PPI inputs were higher but PPI outputs were lower which could suggest declining business margins. Industrial production figures were higher from last month. (Click chart to enlarge)

Loonie (CAD): The Loonie is trading mostly higher ahead of Canada’s CPI data which is due out tomorrow.

Euro (EUR): There hasn’t been a lot of news emanating from the euro zone lately which always makes me a bit cautious. The Euro is mostly lower as the current account deficit has increased from the previous reading. (Click chart to enlarge)

Pound (GBP): The Pound is mostly higher after comments from BOE policy-maker Sentence suggested a stronger Pound and higher rates was good for the UK economy. This is not a new stance, however, as he has been voting for rate hikes for some time.

Dollar (USD): I just had to wait this morning for the CPI report to see if what I suspected was right. Sure enough, the number is suspect. The headline came in exactly as expected, showing 1.6% headline inflation, yet the monthly figure increased by .4% vs. expectations of a .3% gain. It is now getting to the point where you can’t even rely on the data so it’s becoming almost a non-issue. Initial jobless claims came in at 410K, moving back to the “fours” after last week’s dip into the “threes”.

Yen (JPY): The Yen is showing a bit of strength this morning after a recent bout of weakness as safe haven demand has returned after yesterday’s FOMC report showed that the Fed isn’t going to change its stance any time soon.

The markets have had a muted response to the CPI data and its almost as if no one cares anymore. Jobless claims here in the US are also a non-issue, unless of course you are one of the 400+K people being laid off each week.

Government reports show that inflation is low, yet if you do anything today you know that is not the case. Trips to the grocery store or the gas station confirm what you already know. But it’s almost as if there is a magic vacuum that sucks those figures right out of the official reports so the Fed can continue to justify its easy money policy.

Confidence in government is an un-measurable metric in the economy, and my guess is that it is near an all-time low. The market reaction to today’s data confirms that. So I expect to see some range-bound action today.

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Australia to Lead the Way in 2011

The outlook for Europe and the U.S. remains mixed but on one thing all pundits can agree; 2011 will be Australia’s year. And even though the new year got off to an auspicious start with floods and other bouts of terrifying weather, Australia’s economy is well-positioned to continue to expand at an accelerated rate. In fact, the Reserve Bank of Australia (RBA) recently revised its 2011 growth forecast.

Noting that the recent floods and the expenses incurred in the aftermath will have a “material effect on the near-term profile of gross domestic product”, the RBA predicted that by June, the economy will be expanding at an elevated clip. The RBA now projects the economy to grow by 4.25 percent in 2011 from its estimate late last year calling for 3.75 growth. The RBA also notes it expects consumer prices to climb by 3 percent compared to its earlier estimate of 2.75 percent.

The revised outlook had an immediate impact on the Australia dollar as investors increased the odds of an interest rate increase. The current benchmark rate â€" known as the Official Cash Rate â€" is 4.75 percent and already far exceeds rates in western regions. The Official Cash Rate sets the interest financial institutions borrow money on the overnight market and a change in the cash rate has a trickle-down impact on retail rates. The extremely aggressive stance by the RBA is seen by the street as a strong hint that the Overnight Cash Rate will be pushed higher within the next few months.

Aussie Dollar Outlook

For 2010, the Australian dollar â€" with the exception of the Japanese yen â€" made significant gains against the major currencies. The outlook for 2011 calls for much of the same:

To understand the RBA’s reasoning, one need only consider the impact an expected increase in shipments of coal and iron ore to China will have on Australia’s exports. Even though China has made attempts to slow the pace of growth, its insatiable appetite for the resources its all-important heavy manufacturing sector relies upon will continue to expand. Australia is well-positioned from both a resources standpoint and geographically to benefit.

There is a dark cloud in what is otherwise a very sunny outlook; the higher Australian dollar adds to the cost of all exports and for markets unable to so easily absorb these extra costs, a decline in foreign sales is unavoidable. This has already become an issue in the manufacturing sector which has seen several months of declining sales.
 
Inflation is also a concern and while the RBA expects to contain expansion to within an acceptable rate, the prospect of further interest rate hikes is considered highly probable. In this age of low-yields in Europe and the United States, expect investor interest in Australia to spike even more in light of the RBA’s latest assessment.

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Hedging High Forex Uncertainty

In forex, everything is relative. That is no less the case for forex volatility, which is low relative to the spikes in 2008 (credit crisis) and 2010 (EU Sovereign debt crisis), but high relative to the preceding 5+ years of stability. On the one hand, volatility is approaching a two year low. On the other hand, analysts continue to warn of high volatility for the foreseeable future. Under these conditions, what are (currency) investors supposed to do?!

Despite the steady pickup in risk appetite in 2010, there remains a whole a host of forex risk factors. On the economic front, GDP growth remains anemic in western countries, unemployment is high, and consumer confidence is low. Budget deficits and national debts are rising, perhaps to the point that default by a major industrialized countries is inevitable. Emerging market countries seem to be ‘suffering’ from the opposite problem, whereby rapid growth, high commodities prices, and capital inflow has caused inflation to rise precipitously. Some Central Banks will be forced to hike interest rates, while others will try to maintain an easy monetary policy for as long as possible. Political crises flare-up without warning, the Euro risks breaking up, and inclement weather is wreaking havoc on food production.

As a result, most currency-market watchers expect 2011 to be a continuation of 2010. In other words, while we might be spared a major crisis, a generalized sense of uncertainty will continue to pervade forex. According to JP Morgan, “Implied volatility on options for major exchange rates averaged 12.34 percent this year, compared with an average of 10.6 percent since January 2000.”  The currency team of UBS predicts, “The divergence between the strength in emerging markets and the unusual levels of uncertainty in the world’s major economies will cause…super volatility,” whereby massive swings in exchange rates will become the norm.

In this environment, there are a number of things that currency traders should do. The first step is simply to be aware that volatility remains high, which means that wider-than-average fluctuations shouldn’t be a surprise. The next step is to decide whether you think that this volatility will remain at an elevated level for the near-term, or whether you expect it to continue declining. (It’s worth pointing out that volatility is not necessarily a perception of absolute risk, but investor perception of risk). The final step is deciding if/how you will tailor your trading strategy in response to changes in volatility.

In fact, you don’t necessarily need to limit your exposure to volatility. If you are a fundamental investor with a long-term approach, you may very well choose to write-off short-term fluctuations as noise. (Of course, if you are a short-term swing trader, you can’t afford to be quite so indifferent). In addition, if your primary interest is in another asset type, you may choose not to hedge any currency risk. Perhaps you believe that the base currency will continue appreciated and/or you relish the exposure to currency movements as an added benefit of asset price exposure. Along these lines, “During the planning stages of the UBS Emerging Markets Equity Income fund, UBS Global Asset Management considered offering investors a hedged share class. The team abandoned the idea when investors showed a preference for unhedged share classes.”

In addition, hedging currency risk is expensive, especially for exotic/illiquid currencies, and currencies characterized by above average volatility. Not to mention that currency hedges can still move against investors, resulting in heavy losses. Still, in 2010, “Corporations from the U.S., Japan and Europe increased the percentage of projected income protected against swings in exchange rates to a record,” which suggests that fear of adverse exchange rate movements still predominates.

Finally, there are those that want to construct second-order currency strategies based entirely on volatility. Using basic options techniques, such as spreads and straddles, it’s possible to profit from volatility (or lack thereof) regardless of which direction the underlying currencies move in. In fact, the CME Group recently introduced a new product series which seeks to perform this very function. Investors can already buy and sell futures based on short-term volatility in the EUR/USD, which will soon be replicated for all of the major currency pairs.

For those of you who like to keep it simple, it’s probably enough to monitor the JP Morgan G7 Currency Volatility Index, which is a good proxy for the risk associated with trading (major) currencies at any given time. When this index spikes, chances are the US Dollar and other safe haven currencies will follow suit.

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Spin Doctors!

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By Mike Conlon | February 9, 2011

At least that’s what is going on this morning as there is little economic data due out that would sway markets in one direction or another. We have been hearing from various Fed officials recently and today the head honcho Bernanke will be out there trying to sell his version of economic reality.

This is not exclusive to the US as overnight the Finance Minister in New Zealand pulled out the “recession card” claiming the country could fall into one in the second half of the year. Talk about not pulling any punches! While it is true that normal economic drivers of growth are not present yet, this blatant attempt to lower the value of the Kiwi has not gone unnoticed.

In the Euro zone, a speech later today from the head of the EFSF (emergency bailout fund) could produce some market activity.

And the countdown to the BOE rate policy decision begins as tomorrow will show whether or not the Central Bank is serious about attempting to control inflation or whether they are content to allow the reduction in government spending to hopefully quell demand.

So stocks markets are lower to start the day, perhaps feeling some residual effect from the Chinese rate hike yesterday.

In the forex market:

Aussie (AUD): The Aussie is lower despite rising consumer confidence figures as risk aversion is starting to increase. Tomorrow is the Australian employment report which will show how the economy is faring. The market may be more concerned with the Chinese rate hike than it let on yesterday.

Kiwi (NZD): The Kiwi is lower after the Finance Minister said it was possible that New Zealand could slip into recession in the second half of the year. The MSCI Pacific stock index was lower, helping take the Kiwi lower. (Click chart to enlarge)

Loonie (CAD): The Loonie is mixed as higher oil prices and increased money flows from the Kiwi and Aussie offset general risk aversion in the market. There is no economic data to speak of for Canada due out this week.

Euro (EUR): It’s also quiet in the Euro zone as German exports decreased last month 2.3% vs. an expectation of a gain of .8%. The head of the EFSF will speak later today and I can’t imagine a scenario where this provides positive sentiment.

Pound (GBP): The Pound is mostly higher after the BRC Shop Index showed prices increased 2.5% lending further credence to the inflation proposition. The UK current account deficit came higher than expected, and a higher-valued Pound would not help correct this situation. Tomorrow’s rate decision couldn’t be more important.  (Click chart to enlarge)

Dollar (USD): The Dollar is benefiting from risk aversion this morning and with no news on the docket it will be up to Fed Chairman Bernanke to light the proverbial fuse.

Yen (JPY): The Yen is mostly weaker despite the mild risk aversion in the market as the Chinese rate hike does indeed affect Japan as well. The focus has shifted toward Europe and the US as worries over the Japanese fundamentals still persist.

Trading days like today can sometimes be difficult as the market hangs on every word of the “spin doctor” who is speaking. One never knows what will set off the market or when a proverbial bomb could drop sending the markets into a tailspin.

Generally speaking, these officials know better than to disrupt the markets with anything deemed overly positive or negative. But unfortunately this type of rhetoric has become accepted as a policy tool designed to affect a currency’s value.

Look no further than New Zealand for proof of that. As irresponsible as it may seem, that is the nature of the beast. These speeches can sometimes provide major volatility to the markets, which is welcomed by those who know how to trade, but feared by those who don’t.

Which type of trader are you?

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Investors Return to Yen-Based Carry Trade

With Japan’s benchmark interest rate holding steady at 0.1 percent for over two years now, investors in Japan are turning to foreign investments in the search for better yields. Investors outside Japan are also entering into carry trades selling the yen in order to buy other, higher-yielding currencies.

“The prospect of any rate rise in Japan is so far away that at some point over the next year it will return as a funding currency,” noted Greg Gibbs, a currency strategist at RBS Australia in Sydney.

Source: Bloomberg

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CFTC / NFA Enhance Regulation of Forex

In 2010, the US Commodity Future Trading Commission (CFTC) formally released a series of new regulations governing all retail foreign exchange dealers. Having given all applicable firms almost six months to bring their operations up to speed with the new regulations, the CFTC is now moving to bring enforcement actions against those that are still not in compliance.

Among other things, the regulations required all retail forex broker-dealers to register accordingly with the National Futures Association (NFA), and for firms that “solicit orders, exercise discretionary trading authority or operate pools with respect to retail forex” to register as introducing brokers. Out of curiosity, I scoured the NFA Background Affiliation Status Information Center (BASIC) to see if/how forex brokers have registered themselves.

As you can see from the table above, there are approximately [I would be grateful if you could inform me of any known omissions!] 28 registered forex firms. However, only 12 of these firms are registered as retail foreign exchange dealers (RFED), and the CFTC recommends that (US) retail forex traders that manage their own accounts should deal with these firms exclusively.

Unfortunately, many firms continue to advertise that themselves as forex brokers when they aren’t registered as such, or even worse, aren’t registered at all. As a result, the CFTC recently filed simultaneous enforcement actions against 14 forex firms, alleging that, “In all but two of the complaints…a defendant acted as an RFED; that is, it offered to take or took the opposite side of a customer’s forex transaction without being registered. In the remaining two complaints, ZtradeFX LLC and FXPRICE, the CFTC alleges that the defendant solicited customers to place forex trades at an RFED without being registered as an Introducing Broker.” The following companies stand accused:

To be a fair, NFA membership doesn’t necessarily imply compliance with NFA regulations, nor does it even guarantee upright behavior. In fact, the NFA is currently scrutinizing all of its member firms “for any signs they are designing computer systems to take advantage of what is known in the industry as ‘slippage,’ or small price movements that happen between the time a customer orders a trade and when that trade is actually executed.” In October, the NFA settled two such cases with IKON FX and Gain Capital, assessing a combined $800,000 in fines. Let’s hope that this isn’t the real explanation for the fact that forex trading is vastly more profitable for brokerages than other types of retail securities trading.

While the NFA hasn’t indicated that this is the case, the current retail forex MO (whereby brokers also act as market-makers) could be under attack. As one advocate for traders told the WSJ, “If a foreign-exchange firm is acting as a market-maker, or taking the other side of a client’s trades, it is doubtful the investor is getting the best possible price.” The problem is at the moment, the industry remains far from transparent, and if not for the NFA investigations, traders probably wouldn’t be able to establish whether their broker(s) acted unscrupulously.

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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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The next shoe to drop?

US Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers. Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.

Beyond their short-term budget gaps, some states have deep structural problems, like insolvent pension funds, that are diverting money from essential public services like education and health care. Some members of Congress fear that it is just a matter of time before a state seeks a bailout, say bankruptcy lawyers who have been consulted by Congressional aides.

New York Times

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Aussie May Have Peaked in 2010

When offering forecasts for 2011, I feel like I can just take the stock phrase “______ is due for a correction” and apply it to one of any number of currencies. But let’s face it: 2009 â€" 2010 were banner years for commodity currencies and emerging market currencies, as investors shook off the credit crisis and piled back into risky assets. As a result, a widespread correction might be just what the doctor ordered, starting with the Australian Dollar.

By any measure, the Aussie was a standout in the forex markets in 2010. After getting off to a slow start, it rose a whopping 25% against the US Dollar, and breached parity (1:1) for the first time since it was launched in 1983. Just like with every currency, there is a narrative that can be used to explain the Aussie’s rise. High interest rates. Strong economic growth. In the end, though, it comes down to commodities.

If you chart the recent performance of the Australian Dollar, you will notice that it almost perfectly tracks the movement of commodities prices. (In fact, if not for the fact that commodities are more volatile than currencies, the two charts might line up perfectly!) By no coincidence, the structure of Australia’s economy is increasingly tilted towards the extraction, processing, and export of raw materials. As prices for these commodities have risen (tripling over the last decade), so, too, has demand for Australian currency.

To take this line of reasoning one step further, China represents the primary market for Australian commodities. “China, according to the Reserve Bank of Australia, accounts for around two-thirds of world iron ore demand, about one-third of aluminium ore demand and more than 45 per cent of global demand for coal.” In other words, saying that the Australian Dollar closely mirrors commodities prices is really an indirect way of saying that the Australian Dollar is simply a function of Chinese economic growth.

Going forward, there are many analysts who are trying to forecast the Aussie based on interest rates and risk appetite and the impact of this fall’s catastrophic floods. (For the record, the former will gradually rise from the current level of 4.75%, and the latter will shave .5% or so from Australian GDP, while it’s unclear to what extent the EU sovereign debt crisis will curtail risk appetite…but this is all beside the point.) What we should be focusing on is commodity prices, and more importantly, the Chinese economy.

Chinese GDP probably grew 10% in 2010, exceeding both economists’ forecasts and the goals of Chinese policymakers. The concern, however, is that the Chinese economic steamer is now powering forward at an uncontrollable speed, leaving asset bubbles and inflation in its wake. The People’s Bank of China has begun to cautiously lift interest rates, raise reserve ratios, and tighten the supply of credit. This should gradually trickle down in the form of price stability and more sustainable growth.

Some analysts don’t expect the Chinese economic juggernaut to slow down: “While there is always a chance of a slowdown in China, the authorities there have proved remarkably adept at getting that economy going again should it falter.” But remember- the issue is not whether its economy will suddenly falter, but whether those same “authorities” will deliberately engineer a slowdown, in order to prevent consumer prices and asset prices from rising inexorably.

The impact on the Aussie would be devastating. “A recent study by Fitch concluded that if China’s growth falls to 5pc this year rather than the expected 10pc, global commodity prices would plunge by as much as 20pc.” [According to that same article, the number of hedge funds that is betting on a Chinese economic slowdown is increasing dramatically]. If the Aussie maintains its close correlation with commodity prices, then we can expect it to decline proportionately if/when China’s economy finally slows down.

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Retail Sales Tales!

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By Mike Conlon | January 21, 2011

This morning we received three different retail sales reports from the UK, Canada, and New Zealand, each telling a different story about economic progress.  Retail sales are a good barometer of consumer expectations and confidence, and can sometimes forecast inflation fears.  The logic is that if you think prices are going up, you may want to buy today rather than chance paying more in the future.

In New Zealand, retail sales increased 1.5% vs. an expectation of 1.1%, though most of that was led by cars and energy as the core rate actually fell for the second straight month.  So traders need to be careful as this actually shows weakness and not strength, as consumers are more focused on debt reduction.

In the UK, retails sales declined .8% vs. an expected .2% decline for the largest December decline on record.  Higher prices and inclement weather is the excuse given, but overall this may be a sign that already inflation is taking a toll.

In Canada, retail sales figures came in much better than expected, posting a gain of 1.3% for November vs. an expectation of .4%.  This shows economic strength and resilience as the Canadian economy appears to be picking up steam.

In the Euro zone, German business climate and expectations figures came in better than expected, though the current assessment figures came in lower.  This improved outlook has helped buoy the Euro higher this morning.

Lastly, my “ I told you so moment” :  the Dollar is weaker today as yesterday’s prevailing thought that China would attempt to tighten monetary policy seems unlikely as it is looking more doubtful that they will raise rates as they are potentially facing a liquidity problem in overnight lending.  Yesterday I mentioned that I thought the market had it wrong and that I didn’t think they would move to tighten. It’s always something!

In the forex market:

Aussie (AUD):  The Aussie is mostly higher on the Chinese sentiment reversal that occurred overnight.

Kiwi (NZD):   The Kiwi is mostly lower on disappointing retail sales figures, despite the headline number.  However Dollar weakness means that it is higher against at least one currency.

Loonie (CAD):   The Loonie is higher against all but the Euro despite lower oil prices.  Retail sales figures came in better than expected and a bit of inflationary pressure could reverse dovish comments made by the BOC earlier this week at their interest rate announcement.  (Click chart to enlarge)

Euro (EUR):  The Euro is higher across the board as anti-Dollar sentiment and a renewed economic outlook from Germany looks positive for the Euro zone.  However, Fitch rating agency has warned of potential future downgrades which may be tempering Euro gains today.  (Click chart to enlarge)

Pound (GBP):   The Pound has rebounded from earlier losses to now posting gains vs. the majority except Euro.  While retail sales were worse than expected, the prevailing thought is that inflation is to blame for the result which should provide Pound hawks with more ammo to support their notion that the BOE needs to be less accommodative with monetary policy.

Dollar (USD):   The Dollar is weaker across the board as the sentiment that China would tighten has been reversed.  Stocks in the US are lower to start the morning and there is no news on the docket that would be a potential game-changer.

Yen (JPY):  The Yen is higher against all but the Pound and Euro as signs of diminishing deflation are starting to emerge.  Japan has been mired in a deflationary “death spiral” for some time and the government has raised its economic assessment for the first time in 7 months.

We can learn a lot from consumer behavior which manifests itself in the form of retail sales figures as this can give us clues as to where each nation may be with regard to inflation.   Higher retail sales can mean that inflation expectations are higher for the future; and lower sales can be a sign that inflation is already a current concern.

It is no secret that global inflation is on the rise, particularly in emerging markets countries, and the question remains whether or not Central banks will be quick enough to act or whether they will be content to allow inflation to scare people into consumption.

While this may deemed “necessary” by some (Bernanke et al), it really is unfortunate that they feel that the only way to economic recovery is through the potential hardships of the people they are meant to govern.

This story isn’t finished folks, not by a long shot!

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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EUR short is a pain

Stronger growth and softer inflation numbers can be a positive combination. So far, the market seems to be focusing on China’s surprising 4th Q GDP release (+9.8%, y/y), rather than the retreating headline CPI print (+4.6% vs. +5.1%). Market positioning believes that the PBOC will have to tighten monetary policy aggressively. In reality, they are unlikely to change their policy course. Investors should expect a ‘normalization of monetary policy amid an expansionary fiscal policy’. The PBOC is likely to favor quantitative tightening through raising reserve requirements and controlling lending activities on ‘their’ time line. Before we all get too risk averse, we have this morning’s US Philly Fed manufacturing survey and weekly jobless claims to digest. Any further proof of a muted recovery in the US job market will deter the Fed from raising borrowing costs and add to this week’s dollars woes. Any surprises, and the EUR bears can breath again.

The US$ is mixed the O/N trading session. Currently, it is higher against 12 of the 16 most actively traded currencies in a ‘whippy’ O/N session.

Nothing surprises the market any more when it comes to US housing data. Yesterday’s unexpected housing starts (+529k, down -4.3%, m/m) will end up being a bigger drag on 4th Q GDP. Similar to building permits (+635k, +16.7%, m/m), starts have been moving sideways for nearly two-years and is -80% off its peak in 2005. Digging deeper, weakness was concentrated in singles (-9%) rather than the lower value-added multiples. On the other hand, the volatile multiple segment was up +17.7%. On average during the last quarter, housing starts averaged +538k and was -8.5% lower than in the previous quarter, marking the third consecutive quarter of declines and the biggest contraction in two years. While one month does not make a trend, the glut of listed and shadow inventory is expected to keep construction muted into the future.

The USD$ is lower against the EUR +0.12%, GBP +0.01%, CHF +0.07% and higher against JPY -0.16%. The commodity currencies are weaker this morning, CAD -0.10% and AUD -0.44%. Yesterday the BOC held to the same script as their October MPR release. Carney remains committed to the view that excess capacity does not get closed off until the end of next year and it will take the same amount of time for the inflation target, convergence of core and the headline, to be capable of printing its +2% mark. Reading between the lines, the market can expect the BOC to remain on hold until the fall. Digging deeper, the BOC has shifted to a consensus view on US growth (+3.2% this year), mostly on the back of Obama’s fall stimulus package. Carney believes that the loonies elevated level and Canada’s declining productivity record will limit export competitiveness and potentially nullify some of the upside for Canada stemming from the pull effect of the US recovery. The upward revisions to US growth get largely cancelled out by the policy maker’s cautious assumptions on Canadian export growth. Finally, their revised output gap estimate is little changed from the last report. It sees spare capacity standing at +1.8% of the economy (+1.9% in October) suggesting little progress in closing off spare capacity. Yesterday’s weaker manufacturing sales data (-0.8% vs. +1.5%) continue to reflect the slow recovery in manufacturing output and a gradual improvement in capacity utilization. The BOC’s dovish position has pushed 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. Expect short term profit taking to remain in focus (0.9978). There is a foreign interest just above parity to buy CAD dollars.

A decline in Asian stocks has reduced the demand for higher-yielding assets. Last nights data out of China has the market convinced that the PBOC will move quickly to hike reserve rates again, this has temporarily increased the appetite for the safety of the greenback and pushed the AUD below parity after three days of gains. Tempering some of the AUD decline was the mix of the data. The strong growth point of view (GDP) and a softer CPI than some might have been expecting can be seen as support for the AUD on these deeper pullbacks. Domestically, the Queensland flood is expected to temper the country’s economic outlook. Governor Stevens kept rates on hold last month (+4.75%) as some indicators were suggesting a ‘more moderate pace of expansion’. Growth is expected to slow this quarter and 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 ahead of US jobless claims (0.9953).

Crude is lower in the O/N session ($90.56 -30c). Oil prices have remained close to home ahead of this weeks EIA inventory report later this morning. It’s anticipated that there will be a seventh consecutive drawdown on inventories. Despite this, prices have tentatively retreated from their 27-month high print late last week after the IEA stated that ‘supplies are ample’, with US inventories ‘well above’ the five-year average. The commodity had experienced six-consecutive winning trading sessions on stronger North American data and on a rapid increase in energy demand from China, the second-biggest user of crude. Last week’s EIA report recorded a decline in stocks and above expectation increases for gas and distillates. Oil inventories fell -2.2m barrels vs. an expected decline of-300k barrels. In contrast, gas supplies increased +5.1m vs. an expected rise of +2.9m barrels, while distillates jumped +2.7m. There are too many hurdles to overcome ahead of the psychological $100 barrel of crude. Technically, the market is not showing a tighter supply or demand balance. OPEC believes that supply and demand are ‘in balance,’ and expect demand growth will slow as the global economy struggles to recover, amid ample supplies. The market expects to meet price resistance in the mid $90’s as there is far more oil in storage, more fuel capacity and more idle oil wells to limit a stronger market rally in theory.

The dollars decline is providing support for commodities as an alternative investment. Investors are relying on fundamental scraps to justify adding to already long positions. The price erosion thus far this year is again promoting physical buying, specifically in Asian and on concerns that Europe’s sovereign-debt crisis may linger, even after the Euro-finance minister’s pledge to strengthen a ‘safety net for debt-strapped countries’. Last week’s successful Euro-periphery bond issues had taken some of the shine off the yellow metal for safe-haven purposes. On a macro level, analysts expect the losses may be limited on concern that inflation will accelerate. The commodity last year completed its tenth annual advance with bullion rallying +30%. Even though the one direction trade feels overdone, there are some strong technical support levels to breach before the markets witnesses a mass exodus. Technical analysts believe that gold ($1,365 -$4.50) will outshine other precious metals in 2011 and peak somewhere above $1,600 in 2012.

The Nikkei closed at 10,437 down-120. The DAX index in Europe was at 7,070 down-12; the FTSE (UK) currently is 5,933 down-43. The early call for the open of key US indices is lower. The US 10-year eased 6bp yesterday (3.33%) and is little changed in the O/N session. Softer US data yesterday mixed with market perception that the US economic recovery will remain sluggish and the fear that today’s jobless claims losses would increase has investors coveting US debt for safe heaven purposes. The lack of US product this week and the ongoing EFSF ‘replacement and replenish’ debate should provide demand for the asset class on deeper pullback in the short term. The market is caught in this tight trading range waiting for any right reason to justify higher or lower rates.

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Euro Champ, Dollar Chump!

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By Mike Conlon | January 19, 2011

The Euro has been higher against the Dollar 7 of the last 8 days as the Dollar has put in an 8-week low as a result of the sluggish US economy.  This morning the US reported declining housing starts which missed analyst forecasts, though there was an increase in mortgage applications and building permits.

This highlights the difference in market sentiment in that the early Dollar strength this year was more a function of concern over the Euro debt crisis and less about the perceived strength of the US economy.

In the UK, fewer people made jobless claims, though the unemployment rate remained steady and as expected at 7.9%

Overnight in Australia, consumer confidence figures came in worse than expected though that should not be a surprise to anyone as the floods that have ravaged Brisbane would cause even the most optimistic to have caution.

Tonight is the first China state dinner at the White House as President Obama attempts to repair a fractured relationship with China.  Man, would love to be a fly on the wall for this one!    Regardless of the outcome, expect little to change as a result.  But it makes for a good headline.

US stock futures are lower to start the day, and trading in European markets is lower as well, though commodities are higher.  So today is a bit of a mixed bag.

In the forex market:

Aussie (AUD):   The Aussie is mixed this morning, trading higher against the N. American currencies but lower against the rest.   Consumer confidence figures fell from 111 to 104.6, the lowest reading in nearly 6 months.  Lower confidence can be attributed to the flooding.

Kiwi (NZD):   The Kiwi is mostly higher going into tonight’s CPI data release.  Prices are expected to have risen significantly, which could put the possibility of another rate hike back on the table.

Loonie (CAD):   The Loonie is lower across the board as a continuation of yesterday’s dovish comments by the BOC has induced further selling.  Oil prices are higher however, so it will be interesting to see if the positive correlation between the Loonie and oil holds up today, or if there is a mean reversion trade out there.  (Click chart to enlarge)

Euro (EUR):  The Euro is higher across the board as it is rallying on anti-Dollar sentiment.  There is little economic data out to day for the Euro zone and as I mentioned yesterday little take away from the meeting of finance ministers with regard to the Euro debt crisis.  (Click chart to enlarge)

Pound (GBP):   The Pound is mostly weaker this morning despite the fact that jobless claims came in lower than expected for the third month in a row.  This data is positive for the UK economy, though it may be under pressure after yesterday’s soaring inflation data.  While under normal circumstances rising inflation would be currency-positive for the country experiencing it, the UK faces the dual challenge of a reduction in spending and higher prices which could produce the dreaded stagflation.

Dollar (USD):    The Dollar is weaker against all but the Loonie as the sluggish economy here makes other currencies more attractive.  Housing starts fell to 529K, lower than the expected 550K and tomorrow’s existing home sales figures may show a declining housing market.  The weak Dollar is encouraging higher commodities prices though, but US stocks are still lower so there may be a possible reversal there.

Yen (JPY):   The Yen is stronger against all but the Euro as Dollar weakness has encouraged safe haven money flows.  A potential economic slowdown in China could help Japanese exports going forward so this may be a play on Chinese GDP figures that are due out tomorrow.

As is evidenced by today’s market, Dollar weakness is still a major driver of world markets and the correlative effects of the Dollar on commodities may be back en vogue.  Existing home sales and initial jobless claims tomorrow will provide a clearer picture of the health of the US economy.

Absent any further complications in the Euro zone, then we could see some continued Dollar weakness.

Tomorrow will also bring economic data from China, as they will report their GDP figures as well as some PPI and CPI data.  Should there be a material slow-down, then that could affect both the Aussie and Kiwi to the downside.

However if China keeps humming along, then it could further increase risk appetite.  Stay tuned!

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!

Tags: account, AUD, Aussie, blog, cad, course, currenc, currencies, currency, dollar, dow, economy, EUR, Euro, forex, forextrading, fx, fxedu, gbp, Il, jpy, market, Mike Conlon, nzd, practice, ssi, time, trade, USD, Yen

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