Another ‘wild and crazy day’ in FX?

Capital markets took a well deserved breather in respect to volatility yesterday after Bernanke’s comments this week sent all asset classes into a tail spin. Cbanks are currently trying to appease investor concerns as they navigate through the minefield of housing and financial debacle that’s taken a firm grip on the global economy. Merrill Lynch and Citigroup earnings will once again upset the apple cart this morning and bring investors back to reality.

The USD$ is stronger in the O/N trading session. Currently it is higher against 9 of the 16 most actively traded currencies in a ‘very subdued’ trading range.

FX Heatmap July 18th, 2008

Yesterday, US housing starts headlines surprised the markets and jumped by more than +9.1% m/m to +1.06m vs. +0.97m in May. The market had been expecting a decline of -1%. Analysts noted that last months data was due to a ‘statistical quirk’ (a change in NY building code-which was a plus for condo starts). It’s widely believed that the headline figure ‘masks the continuation’ of the downward trend in housing activity. Excluding the ‘statistical quirk’, starts would have dropped -4% (slowest pace in 2 decades). With the US economy experiencing more foreclosures, higher mortgage rates and declining property values, one can expect future home sales to remain depressed. By default, it will discourage the starting of new construction projects. Excess inventory will continue to impede future investments. It’s no wonder that Bernanke highlighted this week that ‘….a still deeper contraction in housing markets all represent significant downside risks to the outlook for growth’. Other data reveled that building permits were also up last month, but digging deeper, the report shows the same picture as for starts, with single family down and condos sharply up (+11.6% to +1.09mm/m, ex-NY, permits would have risen +0.7%). A slight plus was seen in the unemployment benefits number which rose less than forecasted, claims increased to +366k from +348k, thus the weekly moving average remains the same.

No surprises with the Philadelphia Fed Manufacturing Index, it contracted for an 8th straight month as orders and employment softened. It came in at -16.3 vs. -17.1 m/m. The index remains very close to the average registered in the 1st half of the year (-20), giving limited signals of improvement in manufacturing activity. As for the labor market, there were no signs of improvement. The number of employees sub-index fell to -7.3 this month vs. -6.9 in June and the average workweek was down to -12.5 from -8.9. This provides further evidence that the labor markets remain under pressure. While prices paid component climbed to 75.6 (highest level in nearly 30 years) from 69.3, further justifying the ‘stagflation’ scenario that the US economy has entered into.

Aside, George Soros is rumored to have purchased back his short position in financial stocks and went short oil instead. This has been one of the better reasons for stronger equities and the USD$ yesterday.

The US $ currently is stronger against the EUR +0.00%, GBP -0.47%, CHF -0.08% and JPY -0.07%. The commodity currencies are mixed this morning, CAD -0.12% and AUD +0.15%. The loonie remains range bound and floundering in ‘no man’s land’. The pace of commodity declines has anchored the CAD$ in a boring range. Despite the ‘black gold’ falling over 10$ this week the loonie did not suffer that much yet. The general malaise of the USD$ has contributed to the loonie attraction by default. One would have expected the currency to suffer by its ‘proximity and association’ with the US (its largest trading partner). Is this a delayed reaction? Excluding commodities, what would be the fair value of the currency? Greater than 1.10 perhaps! Yesterday, government data showed that foreigners increased their holdings of Canadian securities (+$10.7b vs. +$3.5b) another plus for the currency. The BOC released its MPR, saying that inflation will exceed the top of its target range until the 2nd Q of 2009. Currently they believe that the O/N rate of 3% is ‘appropriate’ to slow prices as energy costs stabilize. Some analysts are predicting a hike in the 4Q, while futures traders continue to price in a ‘no change’ for the remainder of the year. This morning the market will be focusing on Canadian wholesale data.

The AUD$ remains under pressure (0.9726) and retreated from it 25-year high as traders pare positions believing that the RBA will cut interest rates in the coming months. Governor Stevens this week has already indicated that rates were high enough to curb inflation (7.25%). Futures traders are pricing in an ease by year end.

Crude is higher O/N ($131.00 up +188c). Crude oil continued its weak bias as natural gas fell 6% with stock pile growing (+104bcf vs. +88bcf) and on signs slower global economic growth is curbing fuel consumption. The weeks EIA report also showed that crude inventories jumped +2.95m barrels to 296.9m last week vs. an estimated -2.2m. With Bernanke saying that risks to US expansion and inflation have risen can only help crudes prices to soften even further over time. Geo-political insurance premium have also eased, with rumors of US diplomats to broker nuclear negotiations with Iran and Israel. This has tempered trader’s speculations that Israel may attack OPEC’s second biggest oil producer. Gas inventories rose +2.47m barrels to 214.2m vs. an expected decline of -800k w/w. Inventories of distillate fuel (including heating oil and diesel), gained +3.19m barrels to 125.7m. The overall report should continue to be very bearish at least until next week. Gas consumption averaged 9.3m barrels a day over the period, down -2.1%, y/y. The market is starting to factor a ‘deeper recession’ taking a firm grip and by default unsettling future demand. Gold advanced yesterday ($964) as energy costs stabilized, thus boosting demand for the ‘yellow metal’ as a hedge against inflation.

The Nikkei closed at 12,803 down -84. The DAX index in Europe was at 6,273 up +2; the FTSE (UK) currently is 5,261 down -25. The early call for the open of key US indices is lower. Yields of the US 10-year bond backed up 8bp yesterday (4.02%) and eased 5bp O/N (3.97%). Treasury prices fell yesterday as financial equities rose on better than forecasted earnings from some US Banks coupled with an unexpected jump in housing starts which reduced the demand for the safety of government debt for the time being. The US curve maintained has maintained its steepening bias (151). This morning will be a different scenario as Merrill Lynch was able to reverse the bonds course; markets can expect more of the same with Citigroup’s release.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell