Are Forex markets acting rational……?

Nationalizing of domestic banks is becoming more frequent (Iceland, UK and France). Is the US to follow? It seems it has very little choice. Yesterday, Bernanke sought overseas help as his novel strategies thus far have made limited progress in restoring calm to the markets. The rabid investor is pushing economies into recession and maybe beyond!

The US$ is weaker in the O/N trading session. Currently it is lower against 11 of the 16 most actively traded currencies, in another ‘volatile’ trading range.

FX Heatmap October 9th, 2008

The credit squeeze contagion is in danger of convincing all investors to seek their own life support. By no means surprising, the ‘dawn’ interest rate cut by the Fed, ECB and four other central banks should probably have come sooner. The objective of this, an unprecedented coordinated effort, is to try and ease the economic fallout of the worst financial crisis since the 1930’s. Policy makers are also trying to liquefy credit markets while cash hoarding prevails. Cbanks have to date been using all the available financial tools to unfreeze capital markets, but their efforts have been in vain, as financial failures intensify. UK and French governments are ready to nationalize banks, as they pledge that no financial institution will be allowed to go bankrupt. The joint decision was made following a global meltdown that has sent stock indexes heading for their biggest annual decline in many a decade. Analysts continue to argue that policy makers should have lowered rates by more, and futures contracts are pricing in further reductions. The global ‘depression’ like symptoms may warrant having rates cut close to zero, increase government spending, while treasuries pump more money into the financial system. The Fed voted unanimously for the move, and said in its statement that ‘incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending’. As per usual, ECB members were a tad more cautious in their assessment. They indicated that the situation ‘has to be assessed as they go along’ and the current rate level ‘will ensure that inflation expectations remain anchored’. Bernanke I am sure would have preferred to have wanted time for the record loans to the financial industry ($700-bailout package) and the new programs (CP), to ‘bear fruit’ before manipulating rates. But, it was the investors take on the current economy that has forced his hand. Time must be allowed to work some of its healing powers.

Yesterday, we notice that the ‘vulture’ investor is making a comeback after US pending home sales unexpectedly jumped +7.4% in Aug. vs. expectations of another monthly decline. This is on the back of home prices continuing to drop as increased foreclosures hit the market. But, analysts remain leery that some of the sales may not be realized come closing time. Layoffs have intensified in Sept. (NFP), due to the financial markets meltdown and increased uncertainty over the US economic outlook. Perhaps today we will get a more accurate unemployment number! Technical and fundamental data does not provide much in way of trading support. Currently, fear and losses dictate capital market reactions. Lemming motions driven by panic actions are causing these large trading ranges. A time out is warranted.

The US$ currently is lower against the EUR +0.87%, GBP +0.14%, CHF +0.07% and higher against JPY -2.12% and. The commodity currencies are stronger this morning, CAD +0.70% and AUD +6.29%. BOC was a member of the ‘Group of 7’ yesterday who slashed O/N borrowing costs. Governor Carney cut key lending rates by 50bp to 2.50%, and futures traders believe he is not done yet. Traders have priced in another 50bp ease at least by year end. The global financial crisis and liquidity constraints continue to build a strong case for further easing, sooner rather than later. Lending constraints are curtailing global economic growth. Canada’s association and proximity to the US (being its largest trading partner) will not allow the Canadian economy to bypass its own recession. Governor Carney said that ‘conditions in global financial markets have deteriorated sharply, and that the US economy has weakened further, and with that commodity prices have fallen abruptly’. He believes yesterday’s actions’ will provide timely and significant support to the Canadian economy’. With O/N lending rates being at 3.00%, Carney had the ‘margin’ to be more aggressive in cutting rates and helping the economy. By default, the loonie trades under pressure as investors remain concerned about the global economy slipping into a deeper recession. The currency has managed to pare nearly 9% of its value over the past week. With global growth concerns spreading to emerging economies (who tend to be staunch supporters of commodity prices), Canada’s commodity exports to these regions will naturally be curtailed. 50% of all exports are commodity based and there’s a concern that a main support for the loonie may no longer be there going forward. Governments thus far have not be able to ease credit or liquidity concerns, as it spreads from ‘Wall Street’ to Main Street’, from ‘North America to Europe’. To date, traders strategy of selling the loonie on USD$ pull backs continues to be the most fruitful option. Investors will take short term cues from the commodity markets while waiting for tomorrow’s Canadian employment data.

Again the AUD$ was the largest mover in the O/N session and the currency has experienced one of the most volatile trading ranges of late (0.6976). Last night it rose by the most since it began trading freely (Dec. 1983) vs. both the JPY and the greenback after Cbanks cut interest rates to ease the financial crisis. Earlier in the week, Governor Stevens slashed O/N borrowing costs (-100bp), which caused the currency to slump as traders unwound their ‘carry trades’. The Cbanks easing at some point should begin to have a beneficial impact on risk assets and the markets. The rate advantage makes the currency attractive as calmer markets entice riskier trades. For now traders will be better buyers on pull backs.

Crude is higher O/N ($89.14 up +14c). Crude prices fell to their lowest level in 10-months yesterday. This was due to the EIA reporting a bigger than expected gain in both crude and gas inventories, as the global downturn impedes demand. Oil supplies rose +8.12m barrels to 302.6m, w/w, as imports and output resumed after production halted due to last months hurricanes. The EIA also cut its forecast for global demand for the remainder of this year, slashing estimates -340k to +86.14m barrels a day. The black stuff tried to pare some of it losses when the market believed that OPEC was intending to meet next month in Vienna to discuss quotas and the effects of the financial crisis on the markets. With no official confirming a potential meeting, the market once again quickly gave up all its gains. Yesterday’s bearish report indicated that US fuel demand averaged about +18.7m barrels a day over the past month (the lowest such readings in 9-years). While US gas demand fell -9.5% last week (the biggest decline in more than 3-years), this can be attributed to a slowing economy directly affecting driving patterns. It was a similar story for gas inventories. Stocks rose +7.18m vs. +1.5m barrels, or 4%, to 186.8m (largest gain in 7-years), as refinery capacity climbed +8.7% to 80.9 percent (biggest in 10-years). Translating the numbers, it seems that demand issues will remain an eyesore regardless of what policy makers will do to try and kick start the ailing economies. Over the past 5-days, crude has managed to give up 15% of its value. Because of this OPEC’s President Khelil said that they will take ‘appropriate measures’ to stabilize these volatile markets. Analysts believe OPEC will only become active once the $80 a barrel level is breached. Over all sentiment certainly remains bearish as Capital Markets believe (despite recent inducements by policy makers) the global economy is slipping into a recession. The Global credit squeeze concerns continue to highlight the possibility of further bank failures (despite G8 countries preparing to nationalize domestic banks) and a long drawn out recession. In the event of a global recession, some analysts foresee crude prices collapsing well below OPEC’s psychological $80 a barrel. Gold remained better bid yesterday ($891) as investors continued to speculate that the coordinated moves by various Cbanks will not be able to revive the ailing financial sector any time soon, this had investors seeking sanctuary in a safe heaven asset class. Do not be surprised to see the ‘yellow metal’ give up some of its recent gains ahead of the G7 meeting on speculation that ministers will support the greenback to stabilize the global financial system.

The Nikkei closed at 9,157 down -45. The DAX index in Europe was at 5,137 up +124; the FTSE (UK) currently is 4,506 up +140. The early call for the open of key US indices is higher. The 10-year Treasury yield backed up 24bp yesterday (3.72%) and another 4bp in the O/N session (3.75%). Despite a coordinated interest rate cut (which saw bond prices initially rise), the Fed announced and held (the same day), the reopening of two tranches in the 10-year bucket ($20b), issues that were being squeezed in repo. They sold a further $40b in cash management and $6b in inflation indexed product, all totaling $66b which managed an upward shift in the US yield curve. Extraordinary times call for extraordinary measures. Investors have been so nervous about the financial crisis that they are holding on to collateral and not lending it out. Thus, there was a need for the Fed to step in and re-open specific tranches. They will issue another $20b 10-year product later this morning. Futures traders are pricing in a 50bp cut by the Fed on Oct.29th.

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