How Much Lower for EURO?

The market is getting the feeling that Euro finance ministers are stalling as they move as stealthy as a bull in a china shop in taking control of this crisis. They are beginning to drop hints that bondholders or PSI may be saddled with bigger losses on Greek debt. So far there are no details about a possible recalibration of the ‘voluntary’ debt exchange. A reopening of negotiations for bond write downs will strip away what ever EU credibility is left amongst investors. A return to the PSI agreement reached two-months ago will only speed up a Greek default.

It seem that EU finance ministers argument will be as far as the private sector is concerned, the Euro-zone have experienced changes since the decision was taken on July 21. Capital markets don’t care what the reason will be. Once you lose confidence in a region it becomes far more difficult to regain. To increase the market tension, finance ministers have also pushed back a decision on the release of Greece’s next 8b-EUR loan installment until after October 13.

A few current buzz words being thrown about do not support the EUR, systemic, contagion, credit risk, liquidity, default, ‘twist’, negative growth and intervention has the market wanting to keep selling EUR on rallies.

Out from left field, but probably should not be considered too much of a surprise after Friday’s Chicago PMI print, was yesterday ISM PMI. US Manufacturing unexpectedly accelerated (51.6) in September as production picked up, easing some of the concerns that the world’s largest economy is stalling. Even more encouraging, was to see employment strengthening (53.8), especially ahead of this week’s employment release. This report is in stark contrast to other global PMI releases that generally show a weaker manufacturing sector as they come to grips with global slowing demand.

Manufacturing in the Euro-zone and Australia both retreated whilst the UK and China this week are beginning to show some ‘life’. Even the Japanese Tankan report showed corporate sentiment is on the ‘UP’s’. Digging deeper, the subindex were generally mixed with new-orders unchanged at 49.6, while production increased to 51.2. The inventory index slipped to 52 while the export print pushed higher to 53.5. On the price side, pressures were little changed, edging a tad higher to 56 from 55.5. At the end of the day, manufacturing accounts for about +12% of the US economy. After employment, prices and exports having accelerated in the month, there is still no sign of this recession everyone keeps talking about!
 
The dollars is higher against the EUR -0.00%, GBP -0.20%, CHF -0.02% and JPY -0.01%. The commodity currencies are mixed this morning, CAD +0.00% and AUD -0.76%.

The loonie was down -2.2% last week, -7.4% on the month and -9% on the quarter. This morning, it has printed new yearly loonie lows. Yesterday, it managed to catch a bid for the first time in four sessions after US manufacturing and construction data beat all expectations. Canada exports approximately +70% of all its goods down south and any data highlighting the positives of the US economy, generally, by rule of thumb, provides a bid for the loonie, but in this case, not for long.

The month and quarter end widow dressing last week had many short term investors seeking shelter and liquidating the remaining of their risk trades ahead of a fundamentally busy week, mixed with Central Bank rate decisions and ending with North American job announcements. During times of stress it’s normally the commodity interest rate currencies, like the loonie, AUD and NZD that underperform. Due to their high sensitivity to risk appetite, ‘Carry’ was one of the worst-performing strategies in September. In particular, the Carry G10 component lost -5.4% in the month.

With riskier assets remaining vulnerable to doubts over the ability of European policy makers to stem a debt crisis that threatens to trigger a global recession, is capable of pushing the loonie through 2010 low levels. Currently, dealers remain better buyers of dollars on pull backs (1.0547).

The AUD has plummeted in the O/N session after the RBA’s hint of rate cuts, despite Governor Stevens leaving key rates unchanged last night at +4.75%. The Bank communique was very cautious on the outlook, leaving the door open for a further rate cut. The RBA concluded its policy statement by describing its current policy stance as appropriate, but nonetheless opened the door to an easing policy change stating that “an improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary.” FI dealers increased the pricing for rates cuts at the 1 November meeting by +18bps to +44bps.

It’s not a surprise to understand that the RBA is still being heavily dependent on how the crisis in Europe affects global growth over the next month. An increase in risk and cuts again will be off the table and visa versa. However, similar to other growth and commodity sensitive currencies, the market bias prefers to be better sellers of the AUD on rallies, until the panic flows have abated. Other data shows that Australia’s building approvals surprised higher and rose +11.4%, m/m in August while the trade surplus widened to +AUD $3.1b in August from +AUD $1.8b in July (0.9451).

Crude is lower in the O/N session ($76.48 down-$1.13c). Oil prices tumbled ahead of the US ISM data release yesterday. The surprising print was capable of paring some of early losses, but, not for too long. The commodity last week posted its largest quarterly decline since the 2008 financial crisis, down-17%. The metal has broken some key technically support levels and this deep pull back may be seen as being a tad over extended. Investors remain concerned about the economic outlook in both the US and in Europe. With European policy makers struggling to contain their fiscal crisis, is expected pressurize commodities on rallies all week. The old support levels now become the new key resistance points.

Last week’s EIA report showed a build up of nearly +2m barrels of crude. This is not bullish and coupled with the Euro sovereign crisis will further pressure commodities. Not to be out done, gas stockpiles also rose +791k barrels to +214.9m last week. Supplies of distillate fuel (heating oil and diesel) increased +72k barrels to +157.7m. Refineries operated at +87.8% of capacity, down -0.5% from the prior week.

Weaker growth predicted by the IMF, which points to lower oil demand, will have dealers thinking of shorting the market again. Expect investors to run into technically selling on some of these rallies.

After posting a quarterly gain of +8%, its biggest this year, gold has again rallied as falling global bourses and lingering worries about a debt crisis in Europe encourages investors to want to own the precious metal, however, a firmer dollar is in danger of capping some of those gains. The metal rising in spite of the dollar probably means the commodities safe haven appeal has returned.

In the last two weeks, gold had one of its “steepest corrections in history, weighed down by a sharp margin increase, the fourth hike this year and heavy liquidation by hedge funds in a technically overbought market”. Demand for ‘physical’ gold is again supporting the market, as the Indian festival season helps drive buying in the world’s biggest gold consumer. Retail gold demand traditionally gains pace from August.

All the bullish factors for wanting to own the yellow metal, like dollar debasement economic imbalances and sovereign periphery debt, remain. To try to apply supply and demand logic in a panicked market is near impossible. The Fed’s efforts to drive interest rates lower to support lending should, by default, support commodity prices ($1,671up+$13.40c).

The Nikkei closed at 8,456 down-89. The DAX index in Europe was at 5,229 down-146; the FTSE (UK) currently is 4,973 down-101. The early call for the open of key US indices is lower. The US 10-year eased-11bp yesterday (1.77%) and is little changed this morning.

Treasuries advanced in the third quarter, the most since the financial crisis of 2008 as Europe’s sovereign-debt crisis and a sluggish US economy spurred demand for the world’s safest assets. Yesterday, the Fed bought +2.5b 30-year longer-term debt to support the economy The 2’s/30’s bond spread continues to narrow. Treasury product also gained as finance ministers prepared to discuss boosting the European Financial Stability Facility.

Long dated securities remain under pressure as investors flatten the US yield curve as the Fed begins buying longer-term debt and selling shorter maturities under Operation Twist this week. Investor’s fear that the US unemployment report could again creep higher is also promoting risk aversion, and attracting the buying of treasuries.

In a low growth and deflationary environment coupled with policy maker’s accommodative positions could keep global rates low for years. At last week Treasury auctions, the three issues drew record low yields for 5’s and 7’s and a record demand for 2’s. The market is hoping to be vindicated by Central Bankers rate announcements later this week.

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