Forex waits to take lead from G7……More ‘cuts’ coming?

$4 trillion and counting, that’s the amount of equity value that investors have managed to erase this week so far, fear and panic are the main motivators; currently, traders are disregarding Cbanks use of innovative financial tools to liquefy credit markets. Deeper interest rate cuts are warranted. Will the G7 surprise us again over the weekend?

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 10th, 2008

Global equity indices are extending their multiday losses as investors grapple with worries about the credit markets and the global economy. It’s currently impossible to stop this running train wreck. Within weeks we have gone from bankrupt financial institutions to potential bankrupt countries (Iceland). The US economy has sunk into a recession and government action is critical to stem the damage. This week we saw Bernanke seek outside help, a coordinated interest rate reduction, which was initially implemented by 7-Cbanks and supported by many others. This of course requires time for the effect to filter throughout the financial system. Futures traders remain aggressive in pricing further rate cuts and expect the Fed to ease another 50bp on Oct. 29th. Domestically, Governments and Cbanks have been pumping copious amounts of cash into the financial system; in hope of liquefy the credit markets. But, to date the aggressive hoarding of cash prevails. Nationalizing financial institutions has even become ‘vogue’ in the UK and France. Treasury Paulson expects to use some of the monies from the ‘toxic waste’ aid to shore up some Banks bottom lines. He anticipates buying ‘none voting seat’ stakes in a wide range of banks by the end of Oct. as the credit freeze increasingly threatens to tip the US economy into a deeper recession. They still intend to buy troubled mortgage backed securities from these financial institutions. But, neutral observers believe a direct capital injection would offer more immediate relief. The Iceland government has completed the takeover of its financial industry, which collapsed under the weight of foreign debt. Technically, this has led to the collapse of their economy and it’s anticipated to take a number of years before the economy may see growth again. Fundamentally and technically it’s difficult to anticipate specific movements in these unprecedented markets. Market observers will be seeking guidance from G7 ministers and the IMF in Washington over the next few days. There is no ‘silver bullet’, time is required to see if any of the innovative financial tools being used to unfreeze credit markets will work. Investors are clear in their opinion, fear and little faith continues to record new records!

Yesterday’s better than expected benefit claims had little effect on the market. The unwinding of the hurricane variable, pushed unadjusted initial jobless claims lower w/w (+478k vs. +498k). The past month has been the highest readings in the financial crisis ‘to date’. Both hurricanes (Ike and Gustav) led to a reported surge of +50k applications for employment insurance (middle two weeks of Sept.), and only +17k hurricane related claims last week as the effect subsided. But, analysts believe that the core weakness in job markets is getting somewhat worse, and the deterioration in continuing claims is to be watched more carefully, as that measure is highly correlated with the unemployment rate (6.1%). Continuing claims increased again to the +3.66m mark vs. +3.60m, w/w. US companies are faced with growing cash flow constraints in a deteriorating economy. One can expect them to have further difficulty accessing credit. Analysts note that companies are entering preservation mode. That is where they will continue to cutback on hours worked and payrolls numbers. Yesterday’s readings remain consistent with 6- figure monthly job shedding in NFP. After what the real economy has witnessed over the past month, this quarter is bound to deliver some eye popping stats.

The US$ currently is lower against the EUR +0.02%, CHF +0.87%, JPY +0.57% and higher against GBP -0.95%. The commodity currencies are weaker this morning, CAD -1.19% and AUD +-2.85%. The loonie managed to print it lowest levels in 18-months as crude continues to trade under pressure. The currency has depreciated 5% this week after a 4% decline last week. With global growth heading for a major downturn, commodities, the backbone of the Canadian economy and exports, will again come under intense pressure and by default should underpin the loonie even further. The Commodity Price Index has declined nearly 7% this week (oil accounts for 21% of the index). With the US in a recession and being Canada’s largest trading partner (75% of all exports head south of the border) does not bode well for export demand. The Canadian economy should expect a spill over effect as it will be impossible for the economy to bypass any recession. This week 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. 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 this week’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. Canada is in the midst of a general election (voting 14th Oct.). The current PM Harper, 2-weeks ago clung to a majority position, now there is a distinct possibility of being voted out of power due to his interpretation of the current financial crisis. This morning there is a full economic calendar to chew on. Any upward surprises from the employment and trade numbers could provide a good opportunity to own the currency (first time this week).

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 (0.6600). This week the currency has plunged the most since it has started to trade freely (Dec. 1983) as global equities plummet, thus convincing investors to cut holdings of higher yielding assets (exiting carry trades funded with loans from Japan). Traders had expected that the coordinated Cbanks easing at some point would have begun to have a beneficial impact on risk assets and the markets. Investors have no risk appetite which can only be expected to put further pressure on the currency in the short term.

Crude is lower O/N ($82.87 down -372c). Crude prices remain under pressure because of investor concern that the coordinated interest rate cut by CBankers this week may not be enough to ‘head-off’ a prolonged global recession. The fear of global contraction has traders heading to the sidelines. Technical analysts believe the market is well on course to penetrate OPEC psychological $80 level. This led OPEC to announce yesterday, that it will be holding an ‘extraordinary’ meeting in Vienna on Nov. 18th. They are very ‘likely’ to cut production because prices have fallen ‘dramatically’ according to the group’s President Khelil (not all members feel this way-especially the Saudis, a US ally). Analysts also expect them to discuss the global financial crisis, the world economic situation and the impacts on the oil market. The US, who consumes approximately 24% of production, is technically in a recession. This week’s bearish EIA report has provided no support for the ‘black-stuff’. It reported 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. US fuel demand is averaging 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. Gold has rallied to a 2-month high ($928) in the O/N session. A plummeting equity market has driven investors to seek a safe heaven asset class. One can expect the ‘yellow metal’ to end the week on a high.

The Nikkei closed at 8,276 down -881. The DAX index in Europe was at 4,503 down -383; the FTSE (UK) currently is 4,070 down -243. The early call for the open of key US indices is lower. The 10-year Treasury yield backed up 3bp yesterday (3.77%) and remain better bid in the O/N session as equities plummet. Yesterday, treasury prices fell for a 3rd straight day as the Fed held a ‘special debt auction’ similar to the two tranches reopened earlier in the week. The Treasury sold $20b 10-year notes to relieve shortages, add this to the $66b issued on Tuesday, would weigh on any yield curve. A massive amount of supply will enter the market over the coming weeks and traders will be expected again to cheapen up the curve to absorb this entire new product. 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. Futures traders continue to price 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