Will Today’s NFP and ‘Bank-aid’ plan lead to ‘coordinated interest rate cuts’ for Forex?

With all the political strong arm tactics completed and insurance ‘riders’ added, a failed ‘band-aid’ vote is not an option for the ‘house’. Main Street needs some reassurance if NFP starts to print recessionary numbers.

The US$ is weaker in the O/N trading session. Currently it is lower against 10 of the 16 most actively traded currencies, in a ‘subdued’ trading range ahead of this mornings NFP announcement and the ‘bail-out’ package vote in the ‘house’.

FX Heatmap October 3rd, 2008

Global equities remain under pressure as market consensus believes that any financial ‘aid’ package will not be able to prevent the contagion spreading from ‘Wall Street’ to the ‘Real Economy’. US data yesterday provided no surprises, but, solidified the greenback positioning vs. its G8 counterparts. Higher borrowing costs have led the market to believe that there remains a reasonable possibility of an orchestrated coordinated interest rate cut by CBankers. Perhaps waiting for the next calendar dates may not be soon enough. US initial claims edged up +1k to 497k last week, leaving them within analyst’s expectations. It’s worth noting that the labor department attributed approximately +57k of that total (+45k not seasonally adjusted) to the two recent hurricanes. Analysts conclude, in the absence of distortions, first-time filings would have totaled around +440k vs. +430k, w/w. That would be in line of average numbers during recent recessions. But, to date payroll losses have not approached the recession levels of -150-200k per month. Consensus expects a print around the -150k mark this morning. With recent financial re-alignment headlines of late; one should expect the unemployment rate to up tick 2/10 at the very least.
Continuing claims departed from their alternating weak/strong pattern, rising +48k for their 2nd straight week. The print of +3.59m last week solidified another 5-year high.

Other data showed that records continue to be broken; US factory orders fell in Aug. (-4% vs. +0.7%-the most in almost 2-years). This provides further proof that business spending slowed down even before the recent worsening of the ‘credit crunch’. Businesses continue to be squeezed, as the credit crunch has investors demanding the highest yields in nearly a decade for use of capital. The summer strength of the greenback can only hurt export returns in the foreseeable future. Adding the growth concerns of Japan and Europe into the equation and it will only increase the pace of this downward spiral.

As expected the ECB left borrowing costs unchanged at 4.25%, but Trichet indicated that the circumstance have changed dramatically for growth and inflation since the last meeting. He was cagey in his statements as he did not want to preempt the Paris G8 meeting taking place tomorrow. During the press session, Trichet declined to comment on the ECB bias (obviously dovish). He said that we are in exceptional circumstances and that they ‘are ready to act whenever it is necessary’. Market translation, the ECB monetary policy stance has changed. Traders believe a rate cut will probably be delivered in Nov. It all depends on the evolution of economic indicators and inflation, along with financial markets (last week, European governments ‘aided or bailed-out 5-financial institutions). Obviously an ease by the BOE policy makers on Oct. 9th and a cut by the FED on Oct 29th would put further pressure on the ECB. Trichet did not want to use all their bullets this week; they are in effect borrowing time to avoid a wage/inflation spiral. Perhaps the next step will be a coordinated interest rate cut by CBankers.

The numerical effect of this week’s ‘intense’ credit squeeze was released yesterday, the numbers staggering, as the fear of the contagion may be spreading to the ‘Real economy’. The report reflects an expansion of the Fed’s balance sheet and emergency lending programs to combat the ‘global credit crises’. Investment dealers and Commercial banks borrowed $348.2b from the Fed, which is an increase of 60%, w/w. Loans via the discount window to commercial banks jumped $10b to $49.5b (surpassing 2001 data after the terrorist attacks). Security firms borrowed $146b vs. $105b. With Banks hoarding cash further emphasis the need for lower borrowing rate policy to be implemented on a coordinated global scale. Even this morning rates are tighter.

The US$ currently is lower against the EUR +0.34%, GBP +0.27%, CHF +0.39 and JPY +0.21%. The commodity currencies are stronger this morning, CAD +0.19% and AUD +0.62%. The loonie yesterday was off to the races after breaking out of its tight trading range. Like most of the G8 currencies, it remains under pressure vs. its southern neighbor. The depreciation of commodity prices has led to investors putting a firm ‘choke hold’ on the Canadian dollar. The markets fears that despite the approval of a credit market ‘bailout’, the US economy looks destined on paper to be entering an economic recession. Governments will not be able to prevent the spill over effect from ‘Wall Street’ to Main Street’. The ongoing global credit squeeze has investors shying away from riskier growth currencies like the loonie. Capital market remains focused on the US financial aid package progress through the US ‘House’ before it becomes written in law. The fear that US will enter a deep recession despite what ever aid is handed out can only hinder the loonies’ progress in the short term. Canada is guilty by its proximity and association to its southern neighbor. The US remains Canada largest trading partner, 75% of all exports head south of the border, and 50% of all exports are commodity based. Governor Carney has indicated that any further slowdown in the US economy will affect areas that matter most to Canada. He expects demand for Canada’s products to drop more than anticipated and inflation to slow. This should give Governor Carney the latitude to ease O/N borrowing costs (3.00%) by year end, as the downside risks for slower growth will intensify. Futures traders are pricing in a 50bp ease by Dec. This is on the back of a ‘dovish’ Trichet and the expectation of coordinated interest rate cuts by G7 members (perhaps as early as next week). In the short term, there no love for the loonie, as the greenback dominates the FX markets. Expect traders to be better sellers of the CAD$ on USD$ pull backs in the short term until proven wrong.

The AUD dollar was one of the bigger movers vs. USD in the O/N session (0.7800), as investors were happy to book some profit ahead of this morning’s employment report. But, the currency remains down on the week and under pressure (like most commodity currencies) as investors sell higher-yielding assets on concern that the US bail-out will not stop the world’s largest economy from sliding into a recession. The AUD has dropped more than -10% percent vs. the greenback in the past 3-months, as prices slid for commodities that Australia exports. The fear of the unknown has trader’s better sellers of the currency on rallies, and they have increased their bets that the RBA will cut O/N borrowing costs this month by 50bp (7.00%).

Crude is lower O/N ($93.81 down -16c). Crude oil remains under pressure as Capital Markets believe that the US economy will slip into a recession. Crude prices continued their spiraling decline for a second day as the USD$ printed a new yearly high vs. the EUR and US fuel demand fell to its lowest level since the last recession. With the bank rescue plan receiving the rubber stamp of approval with ease from the Senate, by default it boosted the greenback, which curtailed the appeal of commodities often used as a hedge against a weaker USD. Investors remain skeptical that a ‘bank rescue plan’ will keep the US economy from slowing. The global economy remains very fragile, economic activity in Europe seems to be collapsing faster than in the US (hence tomorrow’s G8 crisis meeting in Paris). The bail-out package (hopefully approved this afternoon by the ‘house’) does not guarantee that there will be no more bank runs or that the US economy will recover anytime soon. The Bank bailouts this week in Europe continues to pressurize the EUR and Sterling respectively. Oil has declined 35% form the highs printed in July, with US manufacturing data contracting this week at its fastest pace in 7-years, can only further fuel demand concerns. ML analysts foresee prices collapsing to $50 a barrel in the event of a ‘global recession’. The momentum will come from US and European oil usage declining faster than expected while production capacity amongst OPEC members is expected to ‘rise’. This week’s EIA report showed a bigger than forecasted increase in supplies as fuel consumption dropped. Crude inventories rose +4.28m barrels to 294.5m vs. an estimated climb of +2.75m barrels. Imports and refinery operations increased after Hurricanes curtailed supplies last month. The 4-week fuel usage has averaged +19m barrels a day (lowest since 2001). Technical analysts now believe with imports remaining high (increased +26% to +8.99m barrels a day) and refinery operations back on line (+72.3% capacity, up +5.6% w/w), the $90 price level is attainable. Gold plummeted yesterday and little changed O/N ($844), jumping ahead of the expected approval of the ‘bail-out’ plan by the ‘house’ this afternoon. As the greenback appreciates vs. the EUR and crude prices fall, this will continue to reduce the demand for the ‘yellow metal’ as a hedge against inflation.

The Nikkei closed at 10,938 down -216. The DAX index in Europe was at 5,645 down -15; the FTSE (UK) currently is 4,849 down -30. The early call for the open of key US indices is higher. 10-year Treasury yields eased 11bp yesterday (3.63%) and a further 2bp O/N (3.61%). The Treasury prices remain better bid (especially in the front end) as traders continue to speculate that the US will enter a recession regardless of whether lawmakers approve the bail-out package to rescue the financial system. Capital markets are looking beyond the vote and are focusing on fundamental data which justifies the beginning of a ‘long deep recession’. The yield curve continues to steepen, 2-10’s spread has widened to 204bp (the widest since Bear Stearns collapse). Traders continue to increase their bets that the Fed will lower borrowing costs 50bp later this month (if not sooner) as the credit crisis weighs on global growth. The FI market expects to be vindicated by this mornings NFP data.

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