The largest economy needs stimulus Take that bet?

The market is suffering withdrawal symptoms, especially after last Friday’s anemic US employment report. With little data for guidance today, traders will have to go ‘cold turkey’, with no fix, until Bernanke and the boys command center stage tomorrow afternoon. Up until now and rather tentatively, Capital Markets have been pricing in a quantitative easing premium by the Fed. They have managed to conjure up various imaginative plays by the Washington team. This could all come to naught with the possible scenario of a confirmed absence of any Fed purchasing of mortgages or treasuries. If so, investors can expect US yields to backup aggressively, equities to plummet and a dollar to find some sort of attraction. That will be then, for today, it’s a slow death by boredom.

The US$ is a tad stronger in the O/N trading session. Currently it is higher against 12 of the 16 most actively traded currencies in a ‘subdued’ trading range.

Forex heatmap

NFP has come and gone, has disappointed, but, hardly that surprising especially with the compelling weaker North American data gathering momentum this quarter. The USD has been the whipping ‘boy’ of choice now that the Euro-zone stress tests have been providing the anti-climatic support for the EUR. This morning’s German export numbers beat analysts July’s expectations, as the global recovery is helping ‘to boost an export-led expansion in Europe’s largest economy’ (+12.3b vs. +10.6b). The EUR has depreciated -7.3% vs. the dollar this year, making exports more competitive outside the 16-nation region. How long can Germany shoulder the rest of Europe? Something has give, the cracks will appear. But, whose will be deeper? Will it be Obama’s or Merkel’s economy?

The USD$ is higher against the EUR -0.05%, GBP -0.09%, CHF -0.23% and JPY -0.41%. The commodity currencies are mixed this morning, CAD -0.04% and AUD +0.07%. The loonie witnessed both ends of its own price extremes on Friday. Prior to Canada’s employment report release, the currency happened to print a three-month high vs. its largest trading partner as investor’s coveted risk. However, after the release of the unexpected rise in Canada’s own unemployment rate to +8%, convinced intraday speculators to reduce their demand for growth currencies, temporarily at least. The currency, month-to-date, has underperformed against most of its major trading partners as US economic data has been less than impressive. Thus far, the CAD has been guilty by association with its largest trading partner. That been said, on dollar rallies there are CAD buyers about. Friday’s employment data has had only a minor impact on the expectations for the BOC next month. Futures traders continue to price in a +60% chance of a Governor Carney +25bp hike before heading to the sidelines for the remainder of this year at least. A strong Canadian economy and the outlook for a ‘dovish’ Bernanke tone this week should ‘temper concern about a faltering global economic recovery’ and keep the loonie in demand on dollar rallies.

Despite remaining somewhat elevated, the AUD has managed to pare some of its recent gains, especially vs. the JPY, weakening for a 3rd-consecutive day last night, as regional bourses extended their decline, and reducing the demand for higher-yielding currencies at the moment. In the present environment, there are only two scenarios that would give the AUD a lift. Firstly, without a sharp ‘further dip in US yields’ and secondly, a market belief that RBA rate hikes are imminent can only drive the currency higher in the short term. Demand for the AUD remains muted on speculation that the FOMC will disappoint and dampen market expectations for a second round of stimulus measures tomorrow. Despite some of the questionable negativity, the currency continues to trade near its three-month high vs. the USD as gains in global bourses and commodities boosted demand for higher-yielding assets. Any pare backs have been tempered by last weeks AUD trade surplus print unexpectedly advancing to a record high last month (+$3.54b), as Chinese demand boosted exports of coal and iron ore. It’s widely expected that the Fed may go into a new phase of asset buying, which will keep US interest rates low, equities higher and risk appetite supported’. Because of the equity actions, the market is a cautious buyer on pullbacks, wary that the recent strong rally technically may be overdone (0.9194). By tomorrow afternoon all these theories could be easily unwound.

Crude is higher in the O/N session ($81.28 up +58c). Crude prices softened again on Friday after a disappointing NFP report raised concerns about the state of the US economy. Not helping matters was last week’s bearish headline inventory report showing that the underlying stock sub-categories were rising. The market again is anticipating another bearish report later this week. The steep drop in last weeks ‘headline’ oil stockpiles has thus far prevented much deeper losses. The EIA report showed that oil inventories fell -2.8m barrels, more than the -1.6m the market had been expecting. On the flipside, gas stocks again advanced by +700k barrels, compared with expectations of an -800k decline. Not to be out done, distillate inventories (heating oil and diesel) also advanced by +2.2m, doubling the expected gain. Digging deeper, the report also revealed that demand, y/y, was little changed and also too low to consume the fuel produced by refiners operating at +91.2% of capacity (highest level in 3-years). Demand is only up +0.2% from the same period last year. The recent macro-data flow indicates that the US activity has slowed down and the market should expect further price pull back as the ‘one directional’ move may be overdone. US fundamentals continue to show a market that is still overstocked, particularly on the product side. Speculators remain better sellers on up-ticks in the short term.

Gold has rebounded from some very strong technical levels last week. On Friday, after another disappointing employment report, speculators sought sanctuary in the safer heaven asset classes of Treasuries and precious metals. The commodity also found traction on speculation that prices near its recent lows would fuel demand for the physical asset as China’s plans to relax various trading commodity rules. Many believed that last week’s decline has been overdone. Mind you, a weakening dollar will always increase the demand for the commodity. For most of this year, we have witnessed gold rally on the back of a weaker EUR, for the past 6-months investors have been buying the commodity as a safe heaven asset. Until recently, a weaker dollar had been the biggest factor in supporting commodity prices. Since the record highs witnessed on June 21st ($1,266), the commodity has fallen -4.7%. Historically and fundamentally, this is the ‘slowest’ season for physical demand and now with China potentially changing the ground rules will drag the metal higher. Year-to-date, the commodity has gained +8.9% ($1,210 +$5).

The Nikkei closed at 9,572 down -70. The DAX index in Europe was at 6,331 up +73; the FTSE (UK) currently is 5,409 up +77. The early call for the open of key US indices is slightly higher. The US 10-year eased 9bp on Friday (2.82%) and is little changed in the O/N session. The treasury market ended the day rallying for a 10th consecutive week, the longest winning streak in 25-years, after the NFP’s private employment sub-category failed to impress. The grab for yield continues as long as the market speculates that the Fed may be forced to add further stimulus. At tomorrows FOMC meeting, we should get a clearer picture on where Bernanke and Co. stand on this matter. The US 2’s/10’s spread (+231bp) continues to narrow after PIMCO expressed their expectations that the Fed will remain on hold for the next 2 to 3-years. This week, the US Treasury will auction $74b of new debt (3’s, 10’s and long-bond), that is more than the $69b average for this particular mix of securities. With global growth concerns, the market is content in owning product on deeper 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