EUR move painful with Bulls now appearing close to top

For many it’s painful seeing the EUR drag itself higher. The currency is trading with a lack of conviction, but as a necessity, the ‘lesser of two evils’, now that the market is shying away from the dollars as a safe-heaven label. With the Fed on a ‘revised growth alert’, weaker US retail sales and a Chinese economic expansion cooling more than expected has the global economy shaping up to witness a deeper 2nd half slowdown. The EU bears can take some comfort that the EUR rally is ‘only’ grinding higher and that there is no lemming-one exit feel to this move. A strong Spanish bond sale this morning, coupled with triggered option barriers and Greece taking steps to consolidate its banking industry have all supported the EUR. The bear’s time will come again as patience is required in the ‘dog day’s of summer’ and perhaps some more capital!

The US$ is weaker in the O/N trading session. Currently it is higher against 8 of the 16 most actively traded currencies in a ‘nervous’ trading range.

Forex heatmap

It was not much of a surprise to see US retail sales come in weaker, however, consumers continue to add to GDP growth. After netting out the effects of revisions, both headline (-0.5%) and core-retail sales (-0.1%) came close to market expectations and certainly highlights a weaker 2nd Q for consumer spending, in stark contrast to the 1st Q. Digging deeper, in nominal terms, retail sales climbed +1% or about +4% compounded and seasonally adjusted, but with the disadvantage of a slower rate of consumer spending. The May headline was revised higher to -1.1% m/m decline as compared to the -1.2%. Unlike the core-sales (ex-autos and gas) which witnessed a downward revisions -1% from -0.8% previously. It’s worth noting that a third of the sub-categories posted a decline (either a drop in sales or a deceleration in growth), dominated by vehicle (-2.3%), gas sales (-2.0) and sporting
goods (-1.4%). Despite gas prices remaining somewhat flat, analysts attribute some of this weakness could be due to lower prices. Discretionary spending (ex-food, health and
gas) fell -0.4% for the second consecutive month. Overall, the deepest declines were reported in the durable goods and gas components. The demand for non-durable goods remains strong.

The details of yesterday’s Fed minutes are well highlighted. The two minute version showed that officials saw no need to boost stimulus to the economy while trimming their forecasts for growth and noting that risks to the recovery had increased. ‘The economic outlook had softened somewhat and a number of members saw the risks to the outlook as having shifted to the downside’. The data of late certainly supports this. The adjustment to expected growth this year was smaller than expected (+3%-+3.5% vs. +3.2% – +3.7%), and the committee provided a fleeting and ‘heavily qualified reference to the potential need to ease further’. Some of this surprise probably reflects the fact that the data is weak. Their projections of unemployment in the future and inflation are both noticeably softer. The core-inflation was reduced by -15bps throughout the three-year forecast horizon. Some members also voiced concern about the possibility of deflation. The ranges for unemployment were lifted by +0.2% in 2011 and about +0.25%in 2012.

The USD$ is lower against the EUR +0.02%, GBP +0.19%, CHF +0.20% and JPY +0.40%. The commodity currencies are weaker this morning, CAD -0.02% and AUD -0.62%. Stellar fundamental reports of late have traders increasing bets that the BOC will hike rates for the remainder of the year. It seems to be a done deal that Governor Carney will raise +25bps next Tuesday and perhaps another +25bps in Sept. At +1%, Carney has the latitude to step back and assess global growth for the 3rd Q, which in fact could persuade policymakers to ‘skip a beat’ and pause, so that they do not get too far ahead of their southern neighbors. With risk appetite being better than it has been over the last trading week favors growth yield sensitive currencies like the AUD and loonie. Any dollar rallies will only give speculators a better ‘average’ opportunity to own the CAD. It’s difficult to find any technical or fundamental reason to ‘not’ own the currency, whether it’s growth, the BOC attempt to normalize rates somewhat (+0.50%) or as a safer-haven proxy. Couple this with commodities has speculators wagering bets that the CAD will outperform other economies whose monetary policy is expected to experience a prolonged period of near-zero benchmark rates. For most of this month, the loonie has followed equities, in fact, the currency has a +85% correlation with the Dow. On the crosses, CAD is holding its own and under normal conditions is seen as a safer way to play a global economic recovery with links to commodities and less banking.

The AUD happened to pare its recent gains on speculation that slower Chinese growth will lead to diminished demand for exports from the commodity, growth sensitive and higher yielding country. Asian regional bourses ended the day in the red after China’s GDP data came in softer than expected and has effectively put a lid on the AUD rally, especially now that the JPY has caught a bid on the crosses. It seems that the only immediate concern for the currency could be the looming federal election to be called by new PM Gillard. Currently, there is little evidence that the overall positive sentiment is running out of momentum. Last week we saw that there was nothing better to drag a currency higher than domestic strong employment numbers. That been said, investor confidence and risk tolerance has been changing intraday, making it difficult to formulate a convincing argument in what to do with the currency on a micro-level. Last week, Governor Stevens left the cash O/N rate unchanged for a second consecutive month (4.50%). In their communiqué, the RBA stated that consumer spending and business investment are expanding. Policy makers are ‘reinstating their view that domestic growth will be about trend’ and are ‘not alarmed by the global demand backdrop’. In retrospect, policy makers remain ‘very upbeat’. Because of equities actions, the market is a cautious buyer on pullbacks, wary that the recent strong rally technically may be overdone (0.8804).

Crude is little changed in the O/N session ($76.91 -13c). Crude prices initially rose yesterday after the weekly EIA report recorded a fall in its headline print, beating the streets estimates by three times, and on the back of refineries increasing their operating rates. However, the Fed’s revised growth forecast in the minutes was able to pare the gains by day’s end. The weekly stocks fell -5.06m barrels, or -1.4%, to +353.1m (the most in 10-months) vs. an expected decline of only -1.5m barrels. This has left crude supplies +7% above the five-year average for the period. The headline print certainly looks bullish, but, with +350m barrels, supplies are not that tight. Digging deeper, gas supplies climbed +1.6m barrels to +221m, w/w, and not unlike the stocks of distillate fuel (heating oil and diesel), increasing +2.94m barrels to +162.6m, almost three times the size of the gain forecasted. With the dollar also declining vs. the EUR has increased the appeal of commodities as an alternative investment. While the headline for crude was bullish, the numbers for gas was bearish. Analysts believe that the gas markets numbers show ‘lackluster demand and will put pressure on the entire energy complex’. We continue to remain range bound with the price action as the market is looking for stronger evidence to tackle the technical support and resistance levels.

A number of factors have been supporting the ‘yellow metal’s’ this week. Gold is rallying on the heels of positive sentiment expressed by the temporary rally in the equity market, a weaker dollar and finally a Portuguese 2-notch downgrade by Moody’s. Strength in commodities has a positively strong correlation with equities. Pick your poison, as every excuse is legitimate to wanting this commodity to be a part of ones portfolio. Technically, the bullish sentiment had been on hiatus with profit taking testing the medium term support levels. Fundamentally, in the short term the metal will find it difficult to rally aggressively, as historically, this is the ‘slowest’ season for physical demand. Despite this, longer term view, market concerns over global economic growth is supporting the ‘yellow’ metal prices on pull backs. Year-to-date, the commodity has gained +11.5% as investors have been content in using the commodity as a hedge against any European holdings. However, all being said, the commodity needs to close above $1,220 sometime soon to justify any bullish momentum ($1,213 +$6).

The Nikkei closed at 9,685 down -110. The DAX index in Europe was at 6,221 up +12; the FTSE (UK) currently is 5,244 down -9. The early call for the open of key US indices is higher. The US 10-year eased 7bp yesterday (3.05%) and is little changed in the O/N session. Treasuries managed to stop the rot as US retail sales fell more than forecasted last month and on the back of the Fed’s growth revisions in their minutes. Even the final US weekly auction, $12b-long bonds, did not provide enough ammunition to cheapen the curve significantly. All wee, the global bourse rally has reduced the demand for the safe heaven asset class. The long-bond results were again solid. The bid-to-cover ratio was 2.89 and in line with recent results. Indirect bids took down 54% of the offering with the bidding been aggressive, 2bps through the WI’s, yielding 4.08%. Demand for Treasuries is moving higher following the results which cap another heavy weak of supply. Current market sentiment has dealers wanting to be better buyers on pull backs.

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