The Credit Tsunami hits FOREX!

No news is good news. Any other news, good or bad, seems to be rocking investor confidence. Political agendas continue to hinder consumer wealth. Wall Street aid has Main Street on edge, as financial failures widen (Germany, Belgium UK). Time is a factor, but time is costing money! Do we see CBankers collectively act this week?

The US$ is stronger in the O/N trading session. Currently it is higher against 13 of the 16 most actively traded currencies, in a ‘whippy’ trading range.

FX Heatmap October 6th, 2008

Friday’s Sept. NFP report was much weaker than expected (contracted -159k vs. -100k). But, it was very much in line with monthly job losses typical of a ‘recession’. The market anticipates conditions to get worse before they get any better (It’s worth noting that the Sept. NFP data was collected before the deterioration in business credit in the 2nd half of the month). It is reasonable to speculate that Oct. will show an even larger decline. The 3-month moving average now stands at -100k, with a minimal revision to previous months’ data. Surprisingly, the unemployment rate held steady at 6.1%, as the labor force participation rate slipped. Other aspects of the report indicated weakening in labor demand, with average hourly earnings rising only +0.2% and the average workweek falling to a cycle low of +33.6 hours. Combined with the plunge in employment, it pushed the index of weekly hours down -0.5% for the month and left it down at an annualized rate of +2% in 3rd Q. Digging deeper, factory jobs fell -51k, while construction was off -35k (both close to the 6-month averages). Job losses accelerated in retail, finance and leisure, while job growth slowed in health and education. In conclusion, this was a weaker than expected report, which may be a prelude to worse things to come. Not all the data was depressing on Friday. The services sector seems to be holding up in the current environment, as the ISM non-manufacturing composite unexpectedly advanced to 50.2 vs. 50.0, m/m. But, most of the strength may be attributed to foreign demand, as ‘new’ export orders jumped to 50.5 (1st reading above 50 in 2-months). Analysts do not expect it to continue to expand in the months ahead, as business investment ‘globally’ dries up. We already know that the US consumer is curtailing their spending patterns as disposable incomes quickly disappear. Digging deeper, one notices that Business activity advanced in Sept. to 52.1, while new orders pushed above 50 to 50.8. The Fed will be happy that that price paid continued to ease as commodity prices came off their highs and inflation in general continues to moderate. Not surprisingly employment suffered further moving down to 44.2. Despite the services side staying afloat for now, the manufacturing sector is weakening, pushing the combined manufacturing and non-manufacturing composite below 50 last month once again. The global economy needs an orchestrated coordinated interest rate cut, to alleviate the credit crisis for starters.

The US$ currently is higher against the EUR -0.70%, GBP -0.68%, CHF -0.40 and lower against JPY +1.46%. The commodity currencies are weaker this morning, CAD -0.60% and AUD -3.11%. The loonie on Friday was off to the races after breaking out of its tight trading range. The CAD$ posted its biggest weekly slump in nearly 40-years, as commodity prices plummeted in the midst of a global credit crisis, which had investors buying the ‘big dollar’. Like most of the G8 currencies, it remained under pressure vs. its southern neighbor, depreciating close to 5% for the week. The depreciation of commodity prices has led to investors putting a firm ‘choke hold’ on the Canadian dollar. The markets fear that despite the approval of a credit market ‘bailout’, the US economy looks destined on paper to be entering an economic recession, which can only be a negative for the Canadian economy. Governments will not be able to prevent the spill over effect from ‘Wall Street’ to Main Street’, from ‘North America to Europe’, then on to China and Asia. The ongoing global credit squeeze has investors shying away from riskier growth currencies like the loonie. 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. 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 the largest mover vs. USD in the O/N session (0.7448), as a deepening global credit crisis damped demand for higher yielding assets. It continues to encourage the unwinding of the ‘carry trade’. Traders are concerned that the US bail-out will not stop the world’s largest economy from sliding into a recession. The AUD$ has dropped more than -14% 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 by 50bp (7.00%) this evening.

Crude is lower O/N ($89.59 down -429c). Crude oil remains under pressure as Capital Markets believe that the US economy will slip into a recession. Investors are doubtful that the $700b bank-rescue plan, emphatically passed by the ‘house’, will boost future demand. Last week crude prices were down 12% on the week. Despite correctly anticipating that the rescue bill would pass, fundamental data is paving the way for a US recession. With the bank rescue plan receiving the rubber stamp of approval with ease from both the Senate and House, by default, it has boosted the greenback, which has curtailed the appeal of commodities often used as a hedge against a weaker USD. The global economy remains very fragile, economic activity in Europe seems to be collapsing faster than in the US. Euro-land is currently working feverously, trying to coordinated survival packages for a number of financial institutions (Fortis, Hypo Real Estate). The Bank bailouts attempts continue pressurize both the EUR and Sterling. With oil declining 40% form the highs printed in July and US manufacturing contracting last week at its fastest pace in 7-years can only ‘fuel’ future 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’. Last week’s EIA report showed a bigger than forecasted increase in supplies as fuel consumption dropped. 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 $85 price level is attainable. Gold remains under pressure ($833) as the greenback appreciates vs. the EUR and crude prices fall; thus reducing the appeal of the ‘yellow metal’ as an alternative investment.

The Nikkei closed at 10,473 down -465. The DAX index in Europe was at 5,514 down -282; the FTSE (UK) currently is 4,723 down -256. The early call for the open of key US indices is lower. 10-year Treasury yields eased 3bp on Friday (3.60%) and a further 8bp in the O/N session (3.52%), as global equities collapsed. Treasury prices remain better bid (especially in the front end) as traders continue to speculate that the US will enter a recession regardless of Friday’s approved bail-out package aiding the US financial system. Capital markets are focusing on fundamental data which justifies the beginning of a ‘long deep recession’. Last weeks employment data, finally delivered recessionary numbers (-159k), which caused the yield curve to remain steep. The 2-10’s spread has widened to 203bp, close to the widest print since the Bear Stearns collapse. Traders have increased their bets that the Fed will lower borrowing costs 50bp later this month (if not sooner) as the credit crisis weighs on global growth. Rumblings of a coordinated interest rate ease ahead of the defined calendar dates continues to get stronger.

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