Faith in the EUR is the lesser of two evils

Believing in the EUR at these elevated prices is difficult. However, markets are giving it a good try despite negotiations between the IMF and Hungary ending. The new government it seems is reluctant to implement any fiscal reforms ahead of the Oct. local election, and that is putting this year’s deficit target at risk. Both their economic and financing picture has changed. Technically, the country could run out of reserves by Nov. if the government remains unwilling to commit to ‘clear fiscal measures to achieve its current target’. The problem, European banks have significant exposures in Hungary. Despite capital markets being less vulnerable than it was a few weeks ago, if the bank stress test (out Friday), come out negative, fiscal and debt uncertainty will hurt. Fundamentally, Hungary and now Ireland, who was downgraded by Moody’s this morning is ‘bad news for the EUR’. But, owning the currency is lesser of the two evils as the market is wary about being long dollars ahead of Bernanke’s HH testimony.

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

Forex heatmap

The annual rate of US CPI for June fell to a new 8-month low of -1.1%. This is certainly a headline print that had various segments of the market uttering deflation. But, digging deeper into Friday’s report one could conclude that this scenario is less likely to happen in the short term. Firstly, the drop in the headline print (-0.1% vs. +0.0%) was due to a -4.1% decline in gas prices. Analysts expect that with oil and natural gas prices rebounding recently, the CPI energy component will increase over the next couple of months. Secondly, the core-CPI inflation is no longer falling. Having dropped into negative territory in March, the 3-month annualized rate has since risen to +1.3%. The +0.2% monthly increase was driven by a +0.8% increase in clothing prices, a +1.3% jump in hotel room rates and a +0.9% rise in used car prices. It’s worth noting that housing costs have also stabilized. On the flip side however, with the US unemployment rate remaining precariously high (+9%) and the recovery showing signs of stumbling, the medium-term risk of deflation should be greater than before.

Friday’s University of Michigan Sentiment index was a huge disappointment (66.5 vs. 74) to all asset classes, even the bond market, which happened to rally. The headline print has retreated back to last summers levels, before the recovery took hold. Digging deeper, there was nothing good to report as both the current conditions and forward looking expectations fell sharply. Some analysts remain cautious and do not want to get carried away with such negativity as they remain somewhat hopeful that ‘consumer spending can remain on a gentle upward bias driven by spending some of their enormous pockets of
idle liquidity that ramped up post Lehman, and by spending some modest
expected income growth’. Let’s hope so.

The USD$ is lower against the EUR +0.53%, GBP +0.45%, CHF +0.45% and higher against JPY -0.37%. The commodity currencies are stronger this morning, CAD +0.38% and AUD +0.56%. There is an 85% strong correlation between the Dow’s movements and the loonie. Everyone and their mother want to own the currency and the last two trading sessions have been able to squeeze out the weak longs as equities saw red. Softer economic data south of the border, Canada’s largest trading partner, had the bull’s paring some of their positions, influenced by weaker commodity prices, ahead or tomorrow’s BOC interest rate announcement. Stellar Canadian fundamental reports had traders increasing their 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 tomorrow 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 neighbor. With the ‘toing and froing’ of risk attitude, dollar rallies has been giving speculators a better ‘average’ opportunity to own the CAD. However, the negative dollar sentiment over the past 3-weeks may warrant a speculator to reassess this trading strategy as the loonie, being apart of North America, is being thrown into the same boat as its southern neighbor. Longer term speculators continue to wager bets that the CAD will outperform other economies whose monetary policy is expected to experience a prolonged period of near-zero benchmark rates.

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. The market now waits on tomorrows RBA minutes. Now that PM Gillard has called an election and if the minutes indicate that Governor Stevens is comfortable with where rates are, even with an elevated CPI number, they market will not expect the RBA to move in early Aug. That is likely to provide more weakness for the currency. With Asian regional bourses ending the day in the red has effectively put a lid on the AUD rally, especially now that the JPY has caught a bid on the crosses. 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. 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 (0.8681).

Crude is little changed in the O/N session ($75.97 down -6c). Crude prices remain under pressure after China’s economic growth eased and the Fed said that the ‘US outlook had softened’. The market is concerned about the fuel demand of the world’s two largest energy consuming nations. Last week’s inventory report, although headline bullish, has not been able to provide any psychological support. The EIA report 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 had 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. This coming week, 39% of analysts believe that crude will fall after government reports again will signal that the US economic recovery is stalling, which in effect will stain fuel demand. Technically, 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 its resistance levels.

Gold tumbled on Friday as the rebound in the EUR reduced demand for the ‘yellow metal’ as a haven against European-debt concerns. Technically, the commodity is within striking distance of major support levels that may convince the bull’s to pare their investment stake in a rally that has been floundering for the past week. A number of factors had been supporting the ‘yellow metal’ of late. Firstly, there was a positive equity market, bullied by the seasonal earning’s reports and secondly a Portuguese 2-notch downgrade by Moody’s was expected to highlight the fragility of the sovereign debt issues. On a bigger picture, 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 should support the ‘yellow’ metal prices on pull backs. However, that been said, weaker longs firstly need to be taken out of the market. Year-to-date, the commodity has gained +9% as investors have been content in using the commodity as a hedge against any European holdings ($1,192 +$4).

The Nikkei closed at 9,408 down -277. The DAX index in Europe was at 6,051 up +10; the FTSE (UK) currently is 5,168 up +10. The early call for the open of key US indices is higher. The US 10-year eased 4bp on Friday (2.95%) and is little changed in the O/N session. Treasuries prices rose on the back of a weaker US consumer sentiment report and on a lack of evidence of inflation in the US economy. With the economic data continuing to come in softer has investor’s grabbing for yield as the market prices in an increase to the ‘extended period of low interest rates’ promised by the Fed. Weaker manufacturing and sales reports is raising market concerns that the economic recovery is faltering. The weaker data has been offsetting the positive earnings season reports. 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