The Real Fairytale!

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By Mike Conlon | April 29, 2011

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

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

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

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

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

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

In the forex market:

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

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

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

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

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

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

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

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

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

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

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

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

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

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Forex Week in Review: April 24-29

It was a trading week with the broad dollar sell-off finding few obstacles in the calendar. The absence of hawkish innovations from the FOMC has been taken by the market as an all-clear to add to bearish USD momentum and carry trades. It seems that its only immediate savior is a renewed Euro-zone crisis. The technicals are again showing that most currency’s are in overbought territory now that many of the short term targets have been printed. Maybe it will be left up to Central Banks to protest, just like the RBNZ did by stating that their currency strength was ‘unfavorable’. Below are some of the highlights of the week:

EUROPE

• Trichet stating that a stronger USD was in the interest of the United States fell on deaf ears this week.
• Greek, Irish and Portuguese spreads continue to widen to Germany. Spain is showing signs of decoupling from the trend. Systemic fears associated with the peripheral funding outlook remain on the backburner.
• UK CBI total factory orders index fell sharply in Apr. to -11 from 5 in Mar. Activity outlook index was mixed with steady business optimism but weaker export confidence. Data is failing to show any evidence of a strong pick-up in the first half.
• UK GDP grew +0.5%, q/q in 1st Q after contracting -0.5% in 4th Q. Construction remained particularly weak, the rebound was driven by strong services performance, up +0.9%.
• EUR Industrial new-orders index rose +0.9% in Feb., following a sharp upward revision to the Jan. print. Net of revision, new orders rose +21.3%, y/y, suggests continued strong growth momentum.
• Swedish consumer and manufacturing confidence indices moderated in Apr. The economic tendency survey fell to 109.8 from 112.3 in Mar. as a result.
• True Finns party were quoted emphasizing the need for compromise in negotiating to participate in the next government, reducing concerns about Finland blocking negotiations for a Portugal EFSF program
• Flash Euro-zone Apr. CPI came in at a +2.8%, y/y. Mar. M3 data showed an acceleration in the y/y rate of increase to +2.3%, which puts the growth rate at its fastest pace in two years. This increases the risk that the ECB will signal a June rate hike at its May meeting.
• Swiss KOF indicator rose to +2.29 from an upwardly revised +2.25.

Americas

• US Sales of New Homes in Mar. increased from an all time low in Feb. (+300k or +11.1% from a revised +270k). However, on an annual monthly basis they are down -21.9% from Mar. 2010. Median prices continue to struggle and are down -2.9%, y/y.
• US Consumer’s current assessment of economic prosperity, fueled by job prospects, edged up +1.6 points this month to 65.4 from Mar.’s unrevised print of 63.4.
• Feb.’s S&P/Case-Shiller House Price Index printed a -3.3%, y/y, decline, deteriorating from a -3.1%, y/y, decline in Jan.
• As expected, Fed kept rates steady. The FOMC statement indicated that the Fed will end its QE2 program as scheduled in June. Policy makes will closely watch inflation, thought the Fed believes the effects from rising oil prices are temporary. They do not seem to be worried about the weakening in the dollar. They argue that by fulfilling its dual mandate, the Fed can cause a stronger recovery which will lead to a stronger dollar.
• US durable goods report was solid on its details. New orders surprised to the upside in Mar. (+2.5%) while Feb.’s report was revised up substantially (+0.7% vs. -0.9%), leading to a positive gain in the first quarter (+2.1%).
• In Canada, a recent poll sees the Liberal party being pushed into third place ahead of next week’s general election by the left wing NDP. An NDP-led minority government is a likely negative for the loonie, as their political mandate and agenda tends to be ‘a little less business friendly, a little less fiscal austere than under a Conservative majority’.
• US economy hit the breaks in the 1st Q, as higher prices, especially gas and food, curtailed consumer spending, limiting seasonally adjusted GDP to print +1.8%.
• US pending home re-sales climbed +5.1% after a revised +0.7% increase the previous month.
• US initial jobless claims increased by +25k to +429k, w/w. The four-week moving average, capable of smoothing out volatility, rose by +9.2k to +408.5k.
• Canada’s economy shrinks in February by -0.2%. Early expectations stood on +0%.
• US consumer sentiment in April rose by +0.2pts, above expectations, coming in at 69.8
• The Fed.’s favorite inflation measure, core-PCE reported as expected +0.1%

ASIA

• Singapore’s CPI-inflation was flat at +5.0%, y/y, in Mar. However, the elevated CPI inflation rate should keep the year-on-year pace of SGD NEER appreciation at around +5.0%-5.5%.
• An FT article flagged critical labor shortages in Australia. They also reported that the Chinese sovereign wealth fund, CIC, will soon receive $100-200bn in new funds from a Chinese government trying to further diversify away from US Treasuries.
• Singapore’s industrial output, seasonally adjusted, rose +22.0%, m/m in Mar.
• Australia’s CPI inflation rose +1.6%, q/q in the 1st Q, pushing the year-on-year rate to +3.3% from +2.7%.Flood related food price spikes and higher oil prices drove the headline. Underlying inflation was also high, rising +0.9%, q/q to +2.3%, y/y in the 1st Q from +2.2%.
• Asian Cbank’s were believed to be intervening moderately to prevent currency strength this week, adding to expectations for more diversification flows out of USD and into other reserve currencies.
• RBNZ made it explicit in its new policy statement that the recent appreciation of the NZD was “unwelcome.”
• Japan’s industrial production data for Mar. revealed much more significant disruption from the earthquake than previously thought. Production plunged -15.3%, m/m, much worse than the -10.6% consensus. On year-on-year basis, it has dropped -12.9%.
• The BOJ left their rate policy unchanged, like the dollar, rate differentials will likely continue to move against the JPY.
• Australia, housing credit rose +0.4%, m/m in Mar. following a +0.5% increase in Feb., taking the y/y rate to +6.6%.
• PBoC again fixed USDCNY to a new low, 6.499, reflecting broad-based dollar weakness rather than CNY strength.

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Korean Won Poised for Further Gains

It was in November 2010 that I last blogged about the South Korean Won. As a result of the standoff with North Korea and a recent flareup in the Eurozone sovereign debt crisis, the Won had plummeted. Still, I viewed these as temporary problems and concluded that, “Ultimately, both the EU fiscal crisis and the tensions with North Korea will subside, which should cause the Won to resume its rise.” Since then, the Won has indeed risen by more than 8% against the US dollar. Rather than call for a correction, however, I’m ignoring my best instincts and arguing in favor of a further rise.

In a nutshell, the Korean Won has almost everything going for it at the moment. In the words of one columnist, “South Korea is today the 15th largest global economic power [and] is also the leading global nation in shipbuilding, production of LCD screens and in the distribution of broadband per capita. It is the third leading nation in the production of semi-conductors, the fifth in automobile manufacturing and in scientific research.” GDP is growing at a healthy clip of 4.2%. After recording real GDP growth in excess of 6% in 2010, South Korea’s economy is projected to grow by a further 4.5% in 2011, which means that it has more than made up for the recession that it suffered alongside the rest of the word in 2008-2009.  Exports reached a record level in 2010, propelling Korea’s current account balance well into surplus. “It seems that a target of $1 trillion of trade this year will be achieved, in spite of unfavorable conditions from the massive quake in Japan and the Middle East unrest,” declared Korea’s commerce minister. On balance then, money coming into Korea well exceeds money flowing out.

Moreover, unlike Japan and China â€" both of whose currencies are hovering around record levels â€" the Korean Won remains about 20% below its 2008 pre-credit crisis high. That means that the Won has plenty of scope for further appreciation before its exporters will be squeezed to the same extent as its Asian competitors. If the Bank of Korea (BOK) has its way, it will be a long time before this even happens. The BOK continues to intervene on behalf of the Won on a daily basis, and as a result, its foreign exchange reserves have risen to $300 billion, a record high.

Granted, Korean inflation is also rising, and most recently touched 4.7%, which is at or above the level in neighboring economies. The Bank of Korea has taken steps to counter this, but it is understandably wary about inadvertently stoking speculative interest in the Won. Thus, it has raised its benchmark interest rate only four times since last summer, and the rate is still at a historically low level. According to the Wall Street Journal, “That’s still well below the 4% to 4.5% level where economists estimate the neutral policy rate to be.”

When you consider both that the carry trade is back in vogue and that most other emerging market currencies have recovered most of their credit crisis losses and then some, it’s downright surprising that the Won hasn’t risen more. Perhaps, lamented one commentator, South Korea still lacks cachet among investors and is known more as the political counterbalance to North Korea than as the economic juggernaut that it has become. Even though its economy is larger than that of Australia, the Won doesn’t have nearly as much appeal as the Aussie.

Since it’s the weekend, I’ll keep this post short and sweet! Suffice it to say that the Won still has plenty of scope for further appreciation, and unless the BOK completely avoids hiking rates, I don’t see real downside pressures. At this rate, it will probably be one of the big success stories of 2011.

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The Real Fairytale!

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By Mike Conlon | April 29, 2011

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

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

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

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

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

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

In the forex market:

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

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

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

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

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

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

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

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

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

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

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

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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Canadian Dollar Weaker on Slowing Economy

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

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

Source: Bloomberg

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Dollar will Rally when QE2 Ends

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

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

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

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

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

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

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

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

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Transparency But Not Truth!

« Fed Watching! | Home

By Mike Conlon | April 26, 2011

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

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

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

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

In the forex market:

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

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

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

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

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

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

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

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

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

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

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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Greek Debt Higher Than Expected

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

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

Source: Bloomberg

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Economic Theory Implies Canadian Dollar will Fall

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

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

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

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

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

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

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

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

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Good Friday!

« Dollar Limbo! | Home

By Mike Conlon | April 22, 2011

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

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

Happy Easter to those who celebrate it! 

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Forex Week in Review: April 16-21

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

EUROPE

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

Americas

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

ASIA

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

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Icelandic Kronur: Lessons from a Failed Carry Trade

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

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

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

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

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

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

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

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

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A Familiar Game!

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By Mike Conlon | April 18, 2011

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

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

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

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

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

In the forex market:

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

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

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

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

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

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

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

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

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

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

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

Topics: What To Look At In The Market |

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UK Growth Expected to Decline

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

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

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

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

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

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

Consumer Price Index â€" Annualized Rate

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

 
Will Get Worse Before It Gets Better

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

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

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

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Where are Exchange Rates Headed? Look at the Data

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

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

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

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

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

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

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

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Tough Love finally for the EUR

Month-end requirement is distorting some of the price action, especially when it comes to the JPY. Economic releases O/N showing that Japan’s growth slowed and unemployment rising should not be capable of pushing the currency to trade at new yearly highs vs. the dollar. Even the bond market was busy, selling the belly of the curve to the Japanese, again pushing prices out of whack. Price action involving month end requirements is always confusing. The market is caught flat-footed. It had been anticipating further broad based dollar selling for US hedge rebalancing. The EUR nosedive will be attributed to the markets nervous reaction to global bourses back peddling. Will the US 2nd Q GDP confirm the markets bearish view of their economy? No matter what, the color red is prominent on dealers trading books already this morning.

The US$ is weaker in the O/N trading session. Currently it is lower against 111 of the 16 most actively traded currencies in another ‘whippy’ trading range.

Yesterday’s US jobless claims came in bang on market expectations (+457k). Many had believed that ‘the seasonals’ would push claims slightly above the trend last week. The four-week average for claims (a stronger gauge of employment trends) fell -4.5k to +452.5k, the lowest level in three months. Even continuing claims came in line with expectations. The seasonally adjusted series for claims happened to advance by +81k to +4.565m vs. a forecast of +4.6m. Digging deeper, the Fed benefits fell by -269k vs. a projected decline of -300k. It’s worth noting that initial claims are about -21% below last years level, while continuing claims is about -26% less. After yesterday’s claims data analysts expect the labor force participation rate will increase, which should push the US unemployment rate higher to +9.7% vs. +9.5% next week. Market consensus for payrolls stands at +110k thus far.

The USD$ is higher against the EUR -0.18% and lower against GBP +0.14%, CHF +0.40% and JPY +0.55%. The commodity currencies are mixed this morning, CAD +0.17% and AUD -0.17%. Yesterday’s Canadian Industrial Product Price Index (IPPI) unexpectedly slipped -0.9% last month, led by petroleum and coal products (-2.3%) and primary metal products (-2.9%). The Raw Materials Price Index (RMPI) also happened to decline -0.3%, largely due to lower prices for non-ferrous metals and animals products. It was the second consecutive monthly decrease. For the IPPI, the 3-month moving average suggests that core-producer prices (ex-food and energy) continue to trend sideways.
The CAD weakened vs. its southern neighbor as equities and crude happened to reverse its earlier advances and in turn temporarily reduced the appeal of higher-yielding currencies. For most of this week the loonie has performed better on the back of stronger commodity and equity prices. Last week the BOC tightened rates 25bp. The interest rate differential scenario seems to be getting the biggest support for now, despite it being a ‘dovish hike’. Governor Carney stated that there was no pre-ordained path for interest rates in Canada. According to his dovish communiqué ‘the global economic recovery is proceeding, but, is not yet self-sustaining’. The 25bp hike last week will ‘leave considerable monetary stimulus in place’, with both the core and total inflation to advance at about a +2% annual rate through 2012 (within their target zone). Some will argue that with signs of a significant slowdown underway in the US, it’s possible that the BOC may be persuaded to move back to the sidelines on the Sept. go-around. Carney has given himself the latitude to step back and assess global growth for the 3rd Q. Medium term momentum points to a stronger loonie, but, that all depends on whether the big dollar is coveted for risk aversion trading strategies again. On dollar rallies there are CAD buyers.

It seems that the JPY has dominated all trading sessions thus far and the higher yielding commodity currencies have managed to be included. The AUD happened to pare more of this weeks gain on future reports expected to show that China’s growth is slowing and on last nights data showing that bank lending grew last month at the weakest pace in seven months. China is Australia’s largest trading partner. Overall, there is still a sign of concerns that the world economy is in a fragile recovery phase. The Kiwi has been under pressure since and falling against all its major trading partners. Earlier this week and after a surprisingly weaker than expected CPI headline print (+0.6% vs. +1%), the AUD was pressurized as the futures traders priced out an RBA tightening next week. This does not rule out the possibility that Governor Stevens will not hike further in the calendar year. Recently, policy makers stated that they are ‘reinstating their view that domestic growth will be about trend’ and are ‘not alarmed by the global demand backdrop’. In retrospect, policy makers remain ‘very upbeat’. Because of equities actions, the market is a cautious buyer on pullbacks, wary that the recent strong rally technically may be overdone (0.8987).

Crude is little changed in the O/N session ($77.76 down -60c). Crude prices happened to ‘too and fro’ yesterday. At one point it aggressively advanced on the back of a weaker dollar and an upbeat equity market. But, that scenario changed and pared the commodity’s advances caused by the signs that a slowing economic recovery in the US will limit fuel consumption in the world’s second-largest energy user. The weekly EIA report happened to add to the commodity’s bearish sentiment. The inventory data stumped all market expectations with its surprising increase. The headline print had stocks increasing +7.3m barrels vs. a market expectation of +1.7m. Couple this with last weeks +3.1m gain and we have a market flushed with the ‘black-stuff’. Despite global demand slowly improving it’s currently have little effect on supplies. Somewhat of a surprise was the lower than expected fuel inventory gains. Gas stockpiles rose by +100k barrels, below expectations for a build of +500k, while distillate fuels advanced by +900k barrels. Analysts had been expecting an increase of +2.1m barrels. The refinery utilization rate also happened to fall to 90.6%, below the expected 91%. The build in inventories even with some weather related production shut downs continue to paint a bearish fundamental picture for the energy sector. Of late, the commodity has been trading in a tight $5 range. The ‘historical’ US summer driving season is over, coupled with a lack of tropical activity in the Gulf are ingredients for justifiable weaker energy prices.

Gold gained for a second consecutive day on speculation that prices near a three-month low will spur increased physical and investment demand. Technically some believe that this week’s decline has been overdone. All week investors have been caught wanting higher risk and seeking higher returns, and owning gold is currently not the answer. With the EUR continuing to stabilize against most of its trading partners had the market selling the asset class. Bigger picture, technically, the bullish sentiment had been on hiatus with profit taking testing the medium term support levels. Fundamentally, in the short term the metal will find it difficult to rally as this is the ‘slowest’ season for physical demand. Technical analysts are trying with might to convince the market that these levels provided a good buying opportunity. The current problem is that the market has built in a large insurance premium over the past few months and with some market stability nervous investors will want to lighten their positions even more. Year-to-date, the commodity has gained +5.8% and is in danger of further losses ($1,171 -60c).

The Nikkei closed at 9,537 down -159. The DAX index in Europe was at 6,112 down -22; the FTSE (UK) currently is 5,295 down -19. The early call for the open of key US indices is higher. The US 10-year eased 4bp yesterday (2.97%) and is little changed in the O/N session. The last of this week’s $104b auctions disappointed. The $29b 7-year sale was 2.78 times subscribed, weaker the four auction average of 2.83. Even the indirect bidders disappointed, taking down 42% as opposed to the 50.9% four-auction average. The direct bidders happened to take down 9% vs. the 10.4% average. Historically, the 7-year basket is always a difficult sell and lying on top of historical low yields does not make it any easier. However, recently the 5-7 year basket has been somewhat attractive to risk adverse trading strategies as traders do not want to be caught too far out the curve. Demand is there if equities underperform. The market will take its cue from this mornings GDP numbers.

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Boom Time for Forex

It has been three years since the Bank of International Settlements’ last report on foreign exchange was released. Since then, analysts could only speculate about how the forex market has evolved and changed.

The wait is now over, thanks to a huge data release by the world’s Central Bank, which showed that daily trading volume currently averages $4.1 Trillion, a 28% jump since 2007. Trading in London accounted for 44% of the total, with the US â€" in a distant second â€" claiming nearly 19%. Japan and Australia accounted for 7% and 5%, respectively, with an assortment of other financial centers splitting the remainder.

This data is consistent with a recent survey of fund managers, which indicated a growing preference for investing in currencies: “Thirty-eight per cent of fund managers said they were likely to increase their allocations to foreign exchange, while 37 per cent named equities and 35 per cent commodities. Currency was most popular even though this was the asset class where managers felt risks had risen most over the past 12 months.” In short, the zenith of forex has yet to arrive.

There are a few of explanations for this growth. First, there are the inherent draws of trading forex: liquidity, simplicity, and convenience. Second, investors are in the process of diversifying their portfolios away from stocks and bonds, which have underperformed in the last few years (on a comparative historical basis). As investors brace for a long-term bear market in stocks and low yields on bonds for the near future (thanks to low interest rates), they are turning to forex, with its zero-sum nature and the implication of a permanent bull market. Additionally, programmatic trading and risk-based investing strategies are causing correlations in the other financial markets to converge to 1. While there are occasional correlations between certain currencies and other securities/commodities markets, the forex markets tend to trade independently, and hence, represent an excellent vehicle for increasing diversification in one’s portfolio.

There is also a more circumstantial explanation for the rapid growth in forex: the credit crisis. In the last two years, volatility in forex markets reached unprecedented levels, with most currencies falling (and then rising) by 20% or more. As a result, many fund managers were quite active in adjusting their portfolios to reduce their exposure to volatile currencies: “The volume growth was really a result of the volatility and the fact that you had real end users actively hedging their exposures.” Another contingent of “event-driven” investors moved to increase their exposure to forex, as the volatility simultaneously increased opportunities to profit. Moreover, these adjustments were not executed once. With a succession of mini-crises in 2009 and 2010 (Dubai debt crisis, EU sovereign debt crisis) and the possibility of even larger crises in the near future, investors have had to monitor and rejigger their portfolios on a sometimes daily basis: “If you have a big piece of news, such as the Greek debt crisis, there’s more incentive to change your position,” summarized one strategist.

What are the implications of this explosion? It’s difficult to say since there is a chicken-and-egg interplay between the growth in the forex market and volatility in currencies. [In theory, it should be that greater liquidity should reduce volatility, but if we learned anything from 2008, it is that the opposite can also be the case]. As I wrote last week, I think it means that volatility will probably remain high. Investors will continue to adjust their exposure for hedging purposes, and traders will churn their portfolios in the search for quick profits.

It will also make it more difficult for amateur traders to turn profits trading forex. There are now millions of professional eyes and computers, trained on even the most obscure currencies. As if it needed to be said, forex is no longer an alternative asset.

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Oil Falls on Growth Fears

Fears that a faltering recovery could weaken demand for energy, pushed prices back down towards $76 a barrel in Asia on Friday. The benchmark crude for August delivery was down 13 cents to $76.38 a barrel at late afternoon Kuala Lumpur time in electronic trading on the New York Mercantile Exchange.

Oil was lower after lacklustre data Thursday from the U.S. that renewed concerns over a slower-than-expected global economic recovery that may hurt crude demand, said Clarence Chu, a trader with market maker Hudson Capital Energy in Singapore.

“Oil is trading sideways and may continue to do so next week amid the economic uncertainties,” Chu said.

Source: Associated Press

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Be Careful What You Wish For!

« Moderate Growth Ahead! | Home

By Mike Conlon | June 25, 2010

Overnight, the US Congress unexpectedly came to a deal and has agreed on bill regarding financial reform and regulation.  The uncertainty surrounding this bill has been weighing on the markets, as it was unclear what the outcome might be.

As news trickles out of the 2000+ page document and what it means for the banks and the market in general, at least the uncertainty has been removed.  Uncertainty= volatility.  Now, whether or not this bill will actually accomplish what it is intended to remains to be seen.  What my experience tells me is that no matter what is in the bill; Wall St. has already prepared for likely scenarios and has already devised ways to circumvent regulation.  In addition, enacting legislation of this magnitude always comes at a cost, and the brunt of that cost is likely to be paid for by consumers, and not the banks themselves.  Banks will simply pass through the new cost so that executives can still buy beach houses.  If you don’t believe this will happen, take a look at bank stocks that are trading higher in the pre-market.

This comes ahead of this weekend’s G-20 meeting, where the US will push other nations to consider enacting similar reform.

Economic data is out showing that US GDP grew 2.7%, vs. an expectation of 3% and personal consumption figures were at 3% vs. an expectation of 3.5%.  This falls in line with what the Fed said the other day that we are seeing growth, albeit moderate.

Overnight, Japanese CPI figures came in at -.9% vs. -1.1% showing signs that deflation may be subsiding.

The market started out in risk taking mode, but it appears that may be reversing.

In the forex market:

Aussie (AUD):  New Australian PM Gillard has backed away from the mining tax that was the eventual downfall of her predecessor and is open to discussion and negotiation.  The tax was largely seen as anti-investment in one of Australia’s biggest industries.

Kiwi (NZD):   The Kiwi is lower despite a widening trade balance surplus but the market is concerned about a potential Chinese slowdown which could hamper demand for exports.   However, this figure fell short of expectations (814M vs. 850M).

Loonie (CAD):  The Loonie is higher this morning as its major trading partner (the US) appears to be the only country not entertaining the idea of reduced spending.  Unlike the other commodity currencies which are more tied to China, expect the Loonie to benefit as long as the US maintains its spending spree.

Euro (EUR):  The Euro is lower continuing the trend of heightened fear from the debt crisis.  Today marks the fourth day in a row that European stocks are lower as we head into the G-20 weekend.

Pound (GBP):  The Pound is mixed this morning and it will be interesting to see what (if anything) comes out of the G-20 meeting.  The UK “tax and axe” strategy is diametrically opposed to the US strategy of “spend, extend, and pretend”.

Dollar (USD):    The Dollar is somewhat mixed today as the market figures out exactly what this new financial regulation means.  In addition, GDP figures were lower than expectations, but showed that growth, while moderate, is occurring.

Yen (JPY):  The Yen is higher this morning, as CPI data showed that deflation came in less than expected.  In addition, minutes from the rate policy meeting showed that there was actually talk of inflation.  The Nikkei was down overnight, and speculation that the G-20 will not come to a consensus over global economic policy has strengthened demand for the safe-haven of the Yen.

All of my years on Wall St. have taught me one thing:  that politicians in Washington DC cannot compete with the brainpower of Wall St.   Today, champagne is flowing as the uncertainty over the worst-case scenario from financial regulation has been lifted.  True, this isn’t a “home-run” for Wall St.; but I can tell you that they have been prepared for EVERY possible scenario to come out of this and already have plans in place to line their pockets at the expense of the general public.

While regulation is good in theory, it always brings about unintended consequences and in the end it is always the consumer that gets hurt.  Now that this is out of the way, the G-20 meeting will be the focus of the weekend but don’t expect anything of substance to come out of it.

The major problem here in the US is jobs.  Period.  Next week’s Non-Farm Payrolls report will show if we are gaining any jobs in the private sector.  If this is a bad number, look out below.

So there is potential for risk over the weekend, but my guess is the G-20 will be a non-event.

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

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China Revalues Its Currency By 4 Percent

It was only last week that I mused about “Further Delays in RMB Revaluation.� Lo and behold, over the weekend, the Central Bank finally budged, by pledging to the members of the G20 that it would � ‘proceed further with reform‘ of the exchange rate and ‘enhance’ flexibility.� Upon reading this, I suppose I should have felt stupid.

Still, I wondered whether the move was aimed as a political sop designed to appease Western countries, rather than a meaningful change in China’s forex policy. My suspicions were confirmed on Monday, when the markets opened, and the RMB jumped by a pathetic .4%. All of those who had been hoping for an expecting an instant revaluation a la the 5% jump in 2005 were sadly disappointed.

Most commentators shared my cynicism about the move. According to Goldman Sachs Group Chief Global Economist Jim O’Neill, � ‘It’s pretty astute timing. The timing of it is clearly aimed at the G-20 meeting, which indirectly links to the whole renewed thrust in Congress with protectionist steps against China.’ � If this was in fact China’s intention, it backfired, since it only succeeding only in bringing increased attention to the still-undervalued Yuan. Senator Sherrod Brown called the appreciation � ‘a drop in a huge bucket….We’ve seen China take actions like this before when the spotlight is on, and then revert back to old tricks.� Thus, he and Senator Charles Schumer have announced that they will move forward with a bill to punish China, unless the RMB is allowed to significantly appreciate.

By the Central Bank of China’s own admission, this is unlikely. Instead, it will continue to “keep the renminbi exchange rate at a reasonable and balanced level of basic stability.� In other words, the RMB is still pegged squarely to the US Dollar. It is neither freely floating nor is it pegged to a basket of currencies (in which case it could conceivably appreciate faster against the Dollar, due to the weak Euro). It is technically allowed to rise and fall on a daily basis within a .5% ban, but even this is controlled tightly by the Central Bank, via the so-called Central Parity Rate. If the rate fluctuates too much, state-owned companies often intervene in the markets at the behest of the Central Bank. Legitimate market participants are heavily constrained by a rule that requires them to square all of their positions at the end of every trading session, such that making long-term bets on the RMB’s appreciation would be impossible.

Not that it matters. In the US, where it is legal to make long-term bets on the RMB (via futures contracts), investors are still only projecting a 1.8% appreciation (2.2% relative to the RMB’s pre-revaluation level) over the next year, and a 2.9% appreciation by the end of 2011. In the end, there just isn’t a lot of confidence that China will voluntarily act in a way that is contrary to its own short-term economic interests.

To be sure, there is a possibility that the RMB will be allowed to steadily appreciate, in which case there would be real implications for other financial markets. If the past is any consideration, however, the RMB will rise only modestly against the Dollar, and even more modestly on a trade-weighted basis. Its economy will remain overheated and imbalanced, and if it was headed towards collapse prior to this latest change, it certainly still is.

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