Are Bernanke and the Fed not USD bearish?

Where are the contrarians? They are the individuals who mange to ignore the herd and are able to make money in this environment, eventually, in this one directional play, the lemming LHS action! Economic 101 is ‘not’ adding up. We continue to witness strong earning across the board from consumer goods, industrial and financial’s (Goldman reports today $5.25 vs. $4.18). With that, investor mania has been capable of pushing the Dow back through the psychological 10,000 mark and drag future oil prices above $75 a barrel. There is a ‘but’ and it’s a big one! The FOMC minutes yesterday stated that the economic recovery is ‘likely to be restrained’ and that there is a strong need to keep rates low for period of time as the horizon looks uncertain. Someone does not seem to be drinking the same ‘cool aid’. Either Investors or speculators are so far offside or the Fed knows something we don’t again!

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 ‘whippy’ trading range.

Forex heatmap

Yesterday we witnessed US retail sales declining the largest amount this year in Sept. (-1.5% vs. +2.2%, m/m) as car sales plummeted (-10.4%) after the end of the government’s popular ‘Cash-for-Clunkers’ program. However, ex-autos sales were better than expected (+0.5% vs. +0.3%). The Fed relies heavily on the consumer and who accounts for over 70% of total consumption. Analysts fear that with households’ finances likely to remain constrained by falling employment, declining real incomes and tighter credit, future consumption is not considered to grow at these constant rates. The -1.5% drop in retail sales in Sept. followed a +2.2% surge in Aug., which was revised down from an initial estimate of +2.7%. Digging deeper, ex- autos, demand at gas stations rose +1.1%, partially reflecting higher prices. Excluding gas and auto sales, retail sales rose +0.4 percent in Sept. The consumer continues to seek deep discounts before they purchase! Other data showed that US business inventories also declined in Aug ( -1.5%, the largest this year), all on the back of sales climbing, and putting firms in a better position to increase orders going forward. Inventory levels have been the scourge of this recession, but, companies seem to be putting themselves in a position where they can pickup production and investment after drawing down inventories at a record pace in the 1st-half of this year. Of course the biggest factor to support sustainability is employment!

The USD$ is currently lower against the EUR +0.12%, GBP +1.21%, CHF +0.20% and higher against JPY -0.12%. The commodity currencies are stronger this morning, CAD +0.33% and AUD +0.79%. The loonie is back on course and accelerating towards that psychological parity level vs. its largest trading partner. Over the last 6-trading sessions the currency has managed to appreciate 3.2% vs. its southern neighbor (the best performance of all the major trading currencies). Despite stronger than expected Canadian fundamentals (employment report last week where +31k new jobs were created) the demand for commodities continues to give the currency a leg up. Yesterday, Canadian sales of new motor vehicles fell by a seasonally adjusted -0.3% in Aug. after a revised +5.2% the previous month. Despite this, the negative dollar perception will allow the loonie to once again reach parity (last time was in June 2008), but not in a neat straight line, as this extension is somewhat technically overdone. Option traders are pricing in a 62% chance that this will be achieved by year end. More bullish analysts believe it could be by the end of this month! Technically and fundamentally there is no support for the ‘big dollar’. Speculators believe that the pace of a global recovery may quicken. This has risk takers coveting commodity and high yielding currencies on pull backs. Canadian policy makers have been vocal of late expressing their reservations about a strong loonie and its implications on medium term growth. Combing stronger commodity prices and a weak USD sentiment, achieving parity before Christmas is within speculators grasp!

The AUD managed to print new 14-month highs in the O/N session after RBA Stevens said that policy makers ‘cannot be too timid in raising its benchmark interest rate now that the threat of an economic crisis in the nation has passed’ (3.25%).A stronger business confidence print this year was one of the reasons why Governor Stevens at the RBA remains a firm hawk. I guess he now will show rapid normalization of interest rates. What about AUD at parity? (0.9200)

Crude is higher in the O/N session ($75.36 up +18c). With the USD lacking punch, the black-stuff remains better bid. It even managed to break our $10 trading range of $65-$75 yesterday. Market analysts also believe that the upcoming US holiday season will put more vehicle on the road and create further drawdown’s on inventories. Remember, the height of the US holiday driving season was unable to do it! The recent plunge in value by the greenback has convinced speculators to purchase crude and other commodities as a hedge against inflation. Oil fundamentals do not warrant these actions, however, any signs of an uptick in demand for fuel and refiners will be shutting down facilities for that reason. Dealers continue to speculate that demand will increase amid signs that the global economy is emerging from this recession. Prices remain robust after the Asian region raised its 2009 economic forecast. With that and following suit, OPEC revised its target objectives for 2010 on the back of these Asia revisions. No matter what, the black stuff continues to get ahead of its own fundamentals. Speculators are treating the commodity as an ‘investment asset rather than a consumption asset’. Demand destruction remains, last weeks EIA report, while reporting a decline in crude, more importantly was a confirmation of still weak oil product demand in industrial fuels. The EIA report should have been bearish for the commodity. The market will take its lead from this weeks inventory reports. Global output remains healthy. Russia increased its production last month and has now surpassed Saudi Arabia as the largest produce. They have just added to the global glut of the black-stuff. However, at the end of the day it’s the USD that’s pushing this asset class around!

Store of value, store of value! Gold, like an unpredictable thoroughbred, has charged forward and managed to print new record highs yesterday. It’s the debate of deflation and inflation that spurring the ‘yellow metal’ higher as investors are concerned that an economic recovery will promote inflation. Mind you a plummeting dollar is driving investors towards the yellow metal as alternative investment. During this morning’s session, this one way directional rally witnessed some dealers booking profits as a stalling USD curbed the demand temporarily for the yellow metal ($1,056).

The Nikkei closed at 10,238 up +178. The DAX index in Europe was at 5,856 up +3; the FTSE (UK) currently is 5,250 down -6. The early call for the open of key US indices is higher. The 10-year bonds backed up 4bp yesterday (3.42%) and are little changed in the O/N session. Treasuries managed to remain under pressure on the back of US retail sales declining last month less than anticipated (see above), adding to stronger evidence that the US economy is emerging from its worst slump in over 50-years. The long end of the yield curve led the decline and 2’s/10’s have managed to widen the most in 3-weeks (247). Analysts believe that there is good technical support at 3.50% the first time around. However, looking at the big picture, Treasury buybacks are almost over. MBS buybacks have about $250b to go. The US Treasury still had to raise $1.8t per year (more pressure on the curve). Despite the USD at a 14 month low, analysts foresee 4% 10-yr notes before the year-end and 4.5% by middle of next year!

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