No Oscar for King’s Speech-EUR a winner

Mervyn King will not be swayed by ‘adverse publicity over high inflation’. The BOE believes that the increase in prices are not domestically generated. Similar to most CBankers, King is expected to leave rates unchanged until circumstances stabilize and consumer confidence increases. Unlike Cable, the dollars main support this week could come from today’s FOMC announcement and this Friday’s fourth quarter GDP release. Consensus does not believe that this afternoon’s statement will suggest a near term change in monetary policy. Expect Capital Markets to focus on the inflation outlook language and on whether any of the new ‘votes’ on the committee dissent in a hawkish tone.

The US$ is weaker the O/N trading session. Currently, it is lower against 10 of the 16 most actively traded currencies in a ‘tight’ trading range ahead of the FOMC.

Forex heatmap

It was never going to be a surprise to the market. US home prices remained under pressure in November according to the S&P’/Case Shiller Home price index reported yesterday (-1.6% vs. -0.8%). Even with the headline print surfing just above the 2009 year lows, the picture remains bleak. Already, some analysts are calling for a double-dip in prices. Ongoing foreclosures are expected to add to the inventory glut depressing prices, homeowners’ equity and construction even further. The lack of a sustained housing rebound and unemployment above 9% is likely to keep the Fed relatively cautious in this afternoon’s statement.

The market was expecting a stronger consumer confidence print and yesterday’s release did not disappoint (60.6 vs. 53.3). Despite coming in below last May’s 62.7 reading, the details are encouraging. The present situation index saw a sharp jump higher (31 vs. 24.9) and currently straddles a two-year high. The expectation index also saw a solid gain (80.3 vs. 72.3). Analysts note that business present perceptions of improved conditions were strong and that the six-month view showed gains in employment and income. There were notable negatives in the report, consumers planning to buy a major appliance recorded a fresh recession low and inflation expectations rose for a third consecutive month. The positive CB print contrasts other recent releases like the Michigan CSI, which tends to be price sensitive, while the CB release is employment weighted. Even though the data is market positive, the report is not a ‘reliable guide to consumer spending on a monthly basis’. That being said, consumer fundamentals are improving and they are Bernanke’s go to variable.

The USD$ is lower against the EUR +0.10%, GBP +0.28% and JPY +0.14% and higher against CHF -0.34%. The commodity currencies are stronger this morning, CAD +0.06% and AUD +0.09%. Softer than expected inflation data in Canada for December yesterday is reinforcing expectations that the BOC will move cautiously on rising interest rates, supporting the dovish comments by Carney after keeping rates on hold last week. Higher energy prices (+13%) and some base-year effects were behind the pickup in headline inflation in December (+2.4%). Disinflationary pressures from excess capacity are expected to continue to restrain core-inflation (-0.3%). Should the global economy slow and commodity prices drop further, then core inflation will be subdued for quite some time pushing any possibility of tightening further out the curve? Carney said last week that the Canadian economy has ‘considerable slack’ that will keep core inflation below +2% until the end of next year. The release had the loonie temporarily testing parity again, that was short lived with the currency finding some traction on the back of US consumer data. With softer commodity prices and benign inflation, speculators continue look for better levels to sell the CAD.

Earlier this week, the Aussie dollar’s immediate reaction was to fall -0.5% after the release of the CPI data showing headline inflation falling to +2.7%, y/y, from +2.8% in the fourth quarter, vs. a market expectation of +3%. Since then, it has managed to claw back some of these losses, but not with much conviction, especially with softer commodity prices widespread. Market pricing of RBA rate hikes for the next 12 months fell to 28bp from 35bp. Weaker inflation and the devastation caused by floods will very likely delay further RBA hikes beyond the first quarter. Futures dealers expect the RBA to resume its tightening bias in the second half of the year, given rising wages, construction and housing related costs and energy and food prices. Last weeks data out of its largest trading partner, China, has the market convinced that the PBOC will move to hike their reserve rates. Their actions will reduce further the demand for the commodity sensitive growth currency. Earlier this week, Treasury Secretary Swann stated that the country faces an ‘enormous’ economic fallout from floods. ‘Queensland’s rapid development has meant that its economic performance has a much bigger influence over our national economy’. With growth expected to slow this quarter, a tightening policy would not be the prudent course of action. Currently, the market pricing of rate cuts (4.75%) for the RBA February policy meeting and of rate hikes later in the year remains broadly unchanged. Offers again appear at parity (0.9978).

Crude is higher in the O/N session ($86.86 +67c). Crude yesterday fell to a two-month low yesterday amid speculation that OPEC is to boost output and that todays weekly inventory report is expected to record another build up. Earlier this week the Saudi Oil Minister indicated that OPEC may increase production levels to meet increasing global fuel demand. His comments have certainly put a medium term cap on the black stuff. He indicated that global demand was expected to increase around +2% this year. Last week the IEA raised its estimates for this year’s global demand for a fourth consecutive month as the economic recovery seems to be gathering momentum. They anticipate that global consumption will increase by +1.69%. Last week’s US inventory report provided another excuse to offload oil contracts. Crude stockpiles increased +2.62m barrels to +335.7m. Not being left behind were gas supplies rising +4.4m to +227.7m barrels. It’s worth noting that the four week gas demand was +2%, y/y, higher and averaged +9m barrels a day. US refineries ran at +83% of total capacity, a drop of -3.4%. The supplies of distillates (diesel and heating oil) rose by +1m to +165.8m barrels vs. an expected weekly increase of +900k barrels. OPEC believes that supply and demand are ‘in balance’. There is far more oil in storage, more fuel capacity and more idle oil wells to limit a stronger market rally in the medium term. The commodity is expected to test key support levels around $85.

After capping its third consecutive weekly loss on speculation that borrowing costs will rise as the US economy recovers, gold prices have tumbled to a three month low yesterday as demand ‘waned for the yellow metal’ as an alternative investment. With global confidence growing, one gets the feeling that the bulls are trapped and will soon be pushing that panic sell button. Fundamentally and technically the trend has turned rather badly against the longs. Month-to-date, the commodity has fallen -6.3% and only weeks after recording a +30% annual return. Buying has been modest in the commodity, off to its worst start in 14-years. There is serious discussion being given to whether the gold market has peaked or if it is simply making a short-term correction. Aiding the metal is the Euro sovereign-debt crisis and this despite the Euro-finance minister’s pledge to strengthen a ‘safety net for debt-strapped countries’. However, in reality as long as the Euro-zone is able to sell their bonds, there’s less of a flight to quality into gold. The market remains a seller on upticks ($1,335 +$3).

The Nikkei closed at 10,401 down-63. The DAX index in Europe was at 7,142 up+83; the FTSE (UK) currently is 5,988 up+71. The early call for the open of key US indices is higher. The US 10-year eased 4bp yesterday (3.33%) and is little changed in the O/N session. A couple of factors happened to give FI a bid yesterday. The $35b two-year sale was well received and attracted more demand than the average of the last 10 auctions. Indirect bidders took +27% (the lowest in six-months) vs. a 36.6% four-auction average. Direct bidders took 15% vs. a 13.3% auction-average. Traders will now turn their attention to today’s difficult 5-year auction just ahead of the Fed announcement. Yesterday’s bid-to-cover was 3.47, below the 3.66 average. With Obama calling for a spending freeze as a way to reduce the federal government’s budget shortfall has also given the belly of the curve a lift. Capital Markets now wait for Ben’s next move.

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