Conflicting Fed statements confusing markets

One gets the feeling that the USD bears are becoming a tad tired ahead of the holiday season. Conviction and doubt is starting to creep in, aided by both Bernanke and Trichet rhetoric of late. Just when you are prepared to cash out, along comes St. Louis Fed member Bullard, who implied yesterday that the Fed could be on hold until 2012! He was misinterpreted by Capital Markets. We seem to be getting many conflicting Fed statements of late, it’s no wonder we are confused. Global equities under pressure are promoting risk aversion strategies where the ‘carry’ vehicle currencies are coveted once again. Does it have conviction?

The US$ is stronger in the O/N trading session. Currently it is higher against 15 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Forex heatmap

A mixed bag of US data yesterday was not easily digested. Building permits (552k vs. 580k) and housing starts were both ugly prints for the construction industry. Starts managed to return to their lowest level since April (529k vs. 600k), after having flat lined for most of the summer. Analysts have been telling us repeatedly that the US housing remains ‘bloated’ with stock, and we all know that inventory levels have been the scourge of this recession and causing more builders to remain inactive. But once again, 500k new homes are being built, despite demand waning. Then there is the issue of shadow re-sale inventories, this data should be included as a more accurate reading on the current housing situation. Rather that the 28-week supply figure that analysts can conjure up under conventional calculations, including the shadow technique, supply would be close to 14-months. And we have not even included the sub-category of foreclosed and unlisted houses yet! Next spring will bring an end to the various home-buyers incentives and if you add the issues of mortgage rate resets, one can probably paint another ugly picture for the US housing market for a long time!

Both headline (+0.3% vs. +0.2%) and core (+0.25) US CPI came in slightly stronger than expected last month, pushing the year-over-year rate up to -0.2% for headline and +1.7% for core-inflation. Nonetheless, at these levels, inflation still remains subdued with only modest gains expected in the months ahead. The indexes for new and used cars both rose sharply and together they accounted for over 90% of the increase in the index for all items ex-food and energy. This week’s PPI and CPI data legitimizes the Fed’s ‘extended period of time’ for borrowing costs to remain on hold. Bernanke and his policy makers have a dual mandate, maximize employment and maintain price stability (nothing to do with the USD value), however with the unemployment rate continuing to worsen and evidence that inflation is contained, rates could well remain on hold until the end of next year.

The St. Louis Fed member, James Bullard was misinterpreted yesterday by Capital Markets. He said that ‘Policy rates are near zero in the US and the rest of G-7 countries, something not seen in postwar economic history’. That’s a true comment. However, he added ‘that interest rates may stay low for some time and went on to describe that ‘the FOMC did not begin policy rate increases until 2 ½ – 3-years after the end of each of the past two recessions’. Markets interpreted that summer 2009 ‘is’ the end of recession equals rate hike in 2012. Too simplistic! Bullard said ‘the FOMC will be heavily weighing concerns that stem from criticisms that the Fed kept interest rates too low for too long, contributing to the housing market bubble’. Now, that does not equate to 2012!

The USD$ is currently higher against the EUR -0.57%, GBP -0.39%, CHF -0.71% and lower against the JPY +0.31%. The commodity currencies are weaker this morning, CAD -0.52% and AUD -0.90%. After yesterday’s Canadian CPI numbers, seasonally adjusted or not, inflation is not an issue for Governor Carney. Seasonally adjusted headline CPI was up +0.4%, m/m, vs. the more often reported unadjusted figure of -0.1%. The BOC’s core-CPI was up +0.2%, m/m, vs. the seasonally unadjusted print of +0.1%. Core-inflation remains well contained and with the loonie to remain persistently strong, by default we can expect continued downward pressure on import prices giving us no inflation issues! On an unadjusted basis, energy and food prices fell -1.9% and -0.2%, m/m. That’s the second consecutive monthly decline for energy and the third decline for food prices which contributed to the overall non-seasonal monthly decline. The loonie had been pushed higher on the back of the general disdain towards the greenback despite Bernanke and Trichet’s futile attempts to talk up the dollar. Extended low borrowing costs will do that to you. Higher commodity prices consistently support the loonie. This month alone the CAD is the 5th strongest currency vs. its southern neighbor, the top four are also closely commodity linked. Technically, the currency is trading in a defined 3c-range of 1.04 to 1.07. Capital Markets want to test Governor Carney’s intervention and quantitative policies, the policies that the BOC believes need to be implemented to aid the currency from appreciating too fast that it may have longer term effect on Canadian economic growth. Currently, within this tight range, intraday traders are been squeezed daily out of the core positions, whether it’s commodity prices pushing the loonie or risk aversion. Dealers continue to be better buyers of the CAD on USD rallies as the buck’s bear trend is now well established.

Within sight of the 15-month highs earlier this week was too lofty a perch for the AUD. The currency has managed to weaken for a third consecutive day as weaker domestic fundamental reports combined with mixed data out of the US has pressurized global equities and promoted risk aversion trading strategies. Already this week the AUD has managed to pare some of this week’s gains after the RBA minutes implied that three straight lending rate increases may not be on the cards. After appreciating close to +4% vs. the buck this month, futures traders hastily unwound some bets that Governor Stevens would tighten monetary policy again in two-weeks. He said that the pace of further rate increases ‘remained an open question’. However, bigger picture, the currency is well supported by commodity prices and expects dealers to remain better buyers on ‘deeper’ pullbacks (0.9200).

Crude is lower in the O/N session ($79.15 down -43c). For a third consecutive day yesterday, crude prices edged higher after the weekly EIA report confirmed the weakness of the previous day’s soft API print (-4.37m) . With US crude stocks falling by more-than-expected last week and the dollar trading under pressure had the market temporarily penetrating that psychological $80 a barrel level. Crude inventories in the world’s largest energy consumer country fell by -900k barrels last week vs. market expectations of a +300k increase. Confirming their support, both gas and distillate stocks also fell, by -1.7m and -300k barrels respectively. Overall the two reports are bullish for prices. But, the weaker API report had set up yesterday’s market to expect the worse. With oil trading inversely with the dollar and positively with equities, buying interest in oil, like other commodities has risen. Is it sustainable? Some analysts believe we have come too far to fast, demand destruction does not warrant elevated prices. OPEC will remain on hold next month because of concerns about tipping global economies back into contraction. Commodity prices inverse relationship with the greenbacks value seems to be defying gravity over the last few months. Due to softer fundamentals this month, technically the market has once again aggressively got ahead of itself. To date the market has been wishy-washy within a $7 range with very little follow through above the $80 a barrel level. Do not be surprised if we cannot hold current levels again.

Records, records, records, not a day goes by without the yellow metal managing to record one it seems! Gold managed to climb to a new record yesterday as investors sought alternatives to a weakening dollar. Year-to-date the yellow metal has managed to appreciate +30%, aided by record low interest rates and quantitative easy policies of CBankers who have managed to depress the greenback and by default promote the yellow metal as the go to speculative investment. Expect the Bulls to continue to dominate all of the action and remain strong buyers on deeper pull backs even with the dollar finding support from risk aversion this morning ($1,135).

The Nikkei closed at 9,459 down -127. The DAX index in Europe was at 5,762 down -25; the FTSE (UK) currently is 5,328 down -15. The early call for the open of key US indices is lower. The US 10-year bonds backed up 3bp yesterday (3.36%) and are little changed in the O/N session. Treasury prices fell after the market disregarded Fed Bullard’s comments yesterday (see above). Today we will get to see the US refunding numbers for next week (2’s, 5’s and 7’s), making supply the main factor. Expect the remainder of this week to see some selling of the curve as well as selling outright to make room for a holiday shortened week of purchases. On deeper pull backs, the longer end of the US yield curve remains better bid for two reasons, firstly, the Fed will remain on hold and keep rates low for a considerable length of time and secondly, there is a natural foreign demand for US product. Analysts believe that ‘seasonal’s’ are calling for a flattening rally from here (359 spread 2’s -30’s) ahead of ‘month end index extension’.

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