Trichet turning more hawkish?

Trichet said that the ECB ‘will continue to monitor all developments over the period ahead very closely.’ Maintaining this language in his communique this morning would indicate that the ECB will only hike again in July. A shift to ‘strong vigilance’ in the statement would most likely signal an earlier tightening at the June meeting. The street is favoring a July hike, however, recent inflation strength has raised the risk of an earlier move. An indication of a June tightening will have the EUR again testing O/N highs, just ahead of option related knockouts.

The US$ is weaker in the O/N trading session. Currently, it is lower against 13 of the 16 most actively traded currencies in a ‘subdued’ session.

Forex heatmap

Yesterday’s ADP figures should have no material affect on expectations for tomorrow’s employment report. ADP’s estimate of +179k for private non-farm payroll growth fell short of market expectations (+200k). On the plus side, March data was revised higher by +6k to show a gain of +207k jobs. To date, private monthly jobs have increased at a rate of about +200k monthly pace this year. In reality, the pace would have to show monthly gains of +300k to show ‘unambiguous’ improvement in the US labor market.

The much weaker than expected ISM non-manufacturing data has given the investor another reason to be concerned about the US economy and further justifying the Fed’s ‘extended’ monetary policy. The ISM plunged 4.5 points to 52.8 in April, well below expectations (57.4). Perhaps the slightly weak ADP report and the plummeting services ISM may be a strong indication that higher gas prices are finally squeezing the consumer. Digging deeper, the ISM’s business activity index fell to 53.7 from 59.7. The new-orders index slowed sharply to 52.7 from 64.1. Perhaps more worrying was the employment index showing payrolls struggling to grow, 51.9 from 53.7. The US’s slack labor market and stable core-inflation will continue to give the Fed flexibility.

The USD is lower against the EUR +0.47%, GBP +0.01%, CHF +0.51% and JPY +0.46%. The commodity currencies are weaker this morning, CAD -0.34% and AUD -0.32%.

The loonie is guilty by association with the US’s weak data and is underperforming due to its trading ties. The rumors that Soros was exiting his commodity trades have triggered stop-losses in most growth and commodity sensitive currencies. With corporate CAD buying interest not appearing for a while, the loonie is at the mercy of innuendos until we get tomorrow’s North American employment reports. The market expects a strong rebound from last month’s Canadian negative number (+15k vs. -1.5k).

This week, Prime Minister Harper got his majority, which should eventually provide support for the loonie. To date, the loonie has been underperforming against most of its major trading partners. The general election is a CAD-positive result, with the probability that the loonie could revisit its multi-decade low (0.9059 in 2007) if the dollar negative sentiment persists over the next few months. Investors continue to look to own the currency on dollar rallies despite ‘this’ flush out (0.9610).

The Aussie dollar had been trading under pressure outright ever since the PBoC stated that taming inflation is its highest priority. O/N, Aussie retail sales unexpectedly fell in March for the first time in five months (-0.5% vs. +0.8%), leading some analysts to cut first quarter GDP. The RBA earlier this week said that GDP ‘likely’ shrank for the period because of the natural disasters.

This week the RBA were not as hawkish as feared when it came to rates, but hawkish nonetheless. As expected, they left their rate policy on hold (+4.75%). Their statement was hawkish compared to the April release, but certainly caught the rate’s market on the back foot, who had pushed yields higher going into the meeting in the wake of higher than expected first quarter inflation.

Governor Stevens’s communiqué ran a balanced mix of downplaying first quarter inflation due to the floods, noting strength in the labor market and a pickup in corporate credit growth but weakness in household credit. Policy makers replaced the ‘stance of monetary policy remained appropriate,’ with ‘in future meetings, the Board will continue to assess carefully the evolving outlook for growth and inflation’, another nugget for possible rate hikes. Why add this warning now if you think it might only apply in 2012?

Aussie yields are still the highest in the G10 and do look attractive. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on pullbacks for the time being (1.0680).

Crude is weaker in the O/N session ($108.57 -0.67c). Oil has dropped to a two-week low after US data showed supplies surged, and on signals that their economic growth is slowing. A disappointing reading on non-manufacturing activity has prompted concerns about fuel demand.

Yesterday’s inventory numbers were much more bearish than expected. The weekly EIA report showed crude stocks rising +3.4m greater than the +2m barrel build expected by the street, signaling less demand from refiners. On the flip side, gas stockpiles fell-1m barrels, while inventories of distillates (heating oil and diesel), fell -1.4m. Analysts had expected that gas stocks would rise +100k barrels. They were looking for distillate stocks to climb +400k.Gas consumption dropped -2.2% to +8.94m barrels a day last week.

The IEA said it maintains its 2011 global oil demand growth forecast but noted that the high oil prices are beginning to dent demand growth. OPEC has stated that there is ‘no shortage of oil anywhere in the world’ even after supply curtailments in MENA. It’s all about the dollar’s inverse relationship with commodities.

Gold prices have been dragged lower by the liquidating of silver position after the CME hiked initial margin requirements for the third time earlier this week and on reports that a Soros fund was exiting its commodity trade. Until now, the uncertain macro-economic and political environment has encouraged investors to own the yellow metal, as does the continuing weakening of the dollar on the back of US policy makers being slow to tighten their monetary policy.

Gold, as a non-yielding asset, has a higher opportunity cost when interest rates rise. The precious metal has become the currency of choice with the dollar underperforming against its G10 trading partners.

The metals bull-run is far from over with speculators continuing to look to buy the commodity on these deep pullbacks, as the combination of a weak dollar and higher US inflation expectations support demand for inflation hedges. However, short term pain in evident amongst the weaker long positions ($1,514 -$1.10c).

The Nikkei closed at 10,004 up+154. The DAX index in Europe was at 7,377 up+3; the FTSE (UK) currently is 5,979 down-4. The early call for the open of key US indices is higher. The US 10-year eased 4bp yesterday (3.21%) and is little changed in the O/N session.

Investors have push 10-year yields to a six-week low, as private reports show that the US service industry expanded less than forecasted last month and companies added fewer private jobs than projected. Investors have been trimming their risk exposure ahead of tomorrow’s employment reports.

The US treasury announced that it plans to sell $72b in its quarterly sales of long-term debt next week. They will auction $32b-3’s, $24b-10’s and $16b long-bonds. Earlier this week, the Treasury announced that they have halved its original forecast for net issuance in the second quarter from $198b to $142b. They attributed the decline to higher receipts and lower outlays. It’s a necessity to slow its approach to the debt-ceiling. With the coupon issuance to raise nearly $360b, the decline in issuance will come from a further decline in the bill supply, which will obviously affect money market liquidity.

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