EUR’s 11% gain really too much?

Since last Friday’s NFP release the market has had quite a bit to chew on. Over the weekend global leaders have failed to narrow their differences on currency values and have turned to the IMF ‘to calm frictions that are already sparking protectionism’. Historically, this is an institution that generally relies on powers of persuasion. Is this the method that Capital Markets can expect to rely on? It’s a fact that countries favor cheaper currencies to aid growth, just do not be so overt about it. Realistically, the negative dollar trade has become overcrowded and profit taking is inevitable. Perhaps QE2 fears for the buck are slightly overdone? Technical analysts will tell us that we should be expecting a dollar extension to a 1.36 handle. Perhaps this afternoons FOMC minutes will give us a surprise or two.

The US$ is stronger in the O/N trading session. Currently it is higher against 14 of the 16 most actively traded currencies in a ‘volatile’ trading range.

Forex heatmap

Last week it was jobs, this week we get to witness key readings on inflation and retail spending down south. Market anticipates benign inflation to be confirmed again as softer price pressures are in no danger of rising any time soon. With CPI this Friday, market consensus is looking for a +0.2% print, while core (ex-food and energy) is seen at +0.1% after the flat reading the previous month. The Fed is scheduled to release this afternoon its Sept. 21st minutes. Back then it announced it was willing to do more to sustain the US economic recovery.

The USD$ is higher against the EUR -0.62%, GBP -0.33%, CHF -0.73% and lower against JPY +0.06%. The commodity currencies are weaker, CAD -0.35% and AUD -0.63%. The loonie has been under pressure since the headline release of its employment report on Friday (-6.6k vs. +10.2k). According to analysts, the details are more encouraging than the ‘headline drop’. Digging deeper, full-time jobs rose by +37.1k, while the destruction of -43.7k part-time jobs managed to keep the headline in the red. Optimists will tell you the conversion of part-time to full-time jobs is a mild positive, as it expands hours worked, and they tend to be better paying and more stable. In the big picture, the slowdown of the Canadian economy has surprised policy makers of late. Now that the labor market seems to be taking a pause, futures prices are looking for the same in the rate policy decision from the BOC next week. The demise of the greenback had the CAD threatening parity earlier last week as commodity prices provided a bullish backdrop for the currency. That being said, interest rate differentials is not the primary reason for wanting to own the currency. The ongoing threat of QE2 continues to gives all major currencies a leg up on the ‘historical reserve currency’. It seems that reason may be beginning to wear thin as the dollar strengthens against all its major trading partners.

The AUD fell for a second day amid speculation the currency’s advance last week to a record was overdone. A stronger employment report down under earlier this month happened to push the currency to new heights vs. the greenback. Australia’s employers added +49.5k workers and the unemployment rate held at +5.1% in Sept. Month-to-date, the AUD has climbed +8% vs. the buck as data fueled bets that the RBA will raise interest rates before the year ends. Futures traders now see a 42% chance that the RBA will increase its target rate next month, down from 66% last week. The dollar and commodity prices continue to pressurize growth currencies short term. Investors are better buyers on deeper pullbacks as the interest rate differential continues to be of appeal for alternative investments (0.9783).

Crude is lower in the O/N session ($81.05 -$1.16c). Oil prices continue to slide this morning, snapping a three-week record printing price rally, as the dollar strengths vs. the EUR, and curbing the appeal of commodities as an alternative investment ahead of OPEC meeting this week in Vienna. This move had nothing to do with inventories or demand. It is a plain vanilla dollar move. Last week’s inventory report was mixed, a little bearish for oil and bullish for the products, that said, the focus remains on pending QE strategies been implemented by different governments. Crude supplies climbed +3.09m barrels to +360.9m, leaving stockpiles +13% higher than the five-year average. Analysts had expected weekly inventories to rise by +413k barrels. In contrast, gas stockpiles fell -2.65m barrels to +219.9m. Supplies of distillate fuel (heating oil and diesel) slipped -1.12m barrels to +172.5m. Refiners reduced their operating rates by -2.7% to 83.1%. In fact, the drop in refinery runs has probably caused the drop in fuel supplies. Also of note was the drop in fuel consumption, falling -6.4% to +18.5m barrels a day (the biggest weekly decline in nearly seven years). Gas demand also fell -4.2% to +8.99m barrels a day. Until the report, higher inventory supplies had been the biggest inhibitor for a market advance over the past quarter. The market remains wary that the underlying fundamentals have not changed, but the dollar value continues to dictate the direction of commodity prices.

Despite everything, Gold is a commodity in demand close to record highs. The long holiday weekend has be unable to deter investors as the one directional trade has been in demand on fear that the ‘buck’ will remain under pressure in the short term. With market confidence wavering in currency prices, and with free money, it’s making commodities attractive on ‘deeper’ pull backs. Aiding the trade has been the collapse of the dollar vs. its major trading partners. Any time that governments are in the business of printing money then the commodity is bound to do well. Technically, the weakness of the dollar may have been overdone in the short term. The market is currently experiencing a pull back in prices, a dollar rally and paring of bear ‘positions’. To date, gold has outperformed global equities and treasuries (+24%), prompting record investment in gold-backed exchange-traded products. A concern about the strength of the dollar coupled with the sustainable growth issues of the US economy has had investors seeking protection in an asset with a ‘store of value’. With the Fed on the verge of implementing further QE programs ‘tend to be supportive of asset prices and is fueling concerns about the potential longer-term inflationary affect of such measures’. The opportunity costs of holding gold are low due to falling interest rates, by default, the market should expect better buying of the metal again ($1,343 -$10).

The Nikkei closed at 9,388 down -200. The DAX index in Europe was at 6,240 down -70; the FTSE (UK) currently is 5,602 -70. The early call for the open of key US indices is lower. The US 10-year eased 3bp since Friday (2.36%) and is little changed in the O/N session. The market has priced in aggressive ‘future’ buying by the Fed over the last few weeks and last Friday’s employment numbers may have put anticipated buying over the top as record yields continue to be printed. QE2 fundamentally will keep yields low, that being said the market may have dragged bond prices too high as the FOMC announcement could disappoint the FI market that has priced in aggressive new treasury purchases. After the long weekend let’s see what dealers make of the G20 spat.

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