EUR-Turnaround Tuesday gives way to Whiplash Wednesday

Was it the Plunge Protection Team (PPT) or an FT article that discussed coordinated Euro-zone measures to inject capital into European Banks that pushed North American bourses to rally in the final hour yesterday? Talks on coordinated action is not new, albeit stateside or in mainland Europe. Certainly the cheapest stock valuations in two years lured investors and with Ben coming out and warning the market that he remains in the shadows with his arsenal of tools at the ready tends to help.

Despite, the drag higher, currency markets continue to trade with little conviction and remain unable to embrace risk knowing that the Euro banking system is constantly dealing with liquidity and solvency problems. The Moody’s downgrade of Italy’s rating and its report on credit pressures are not good news. Whatever positive sentiment the EUR acquired yesterday is under pressure today. In the O/N session, Asian bourses failed to take their cue from Wall Street yesterday, prompting macro funds to continue unwind their positions funded in dollars and yen. Employment reports this morning will put capital markets risk tolerance to the test.

The market was drowning in rhetoric from the outgoing ECB head honcho and Bernanke. When they did take a breather, investors got a peek at US factory orders. Businesses ordered more computers, communications equipment and other big-ticket items in August, a hopeful sign for the slumping economy. Capital goods orders (+0.9%) are considered a good measure of business investment plans. It was the second gain in three months. However, it was disappointing to see overall factory orders fall -0.2%, and this after rising a downwardly revised -2.1% in July. A sharp decline in auto orders was to blame for the negative prints. The revisions follow July’s jump in automotive orders, which was the biggest increase in eight-years. The shipment of capital goods advanced +2.8% in August. It was the fourth consecutive monthly gain. The increase in orders and shipments seems to suggest that companies kept investing during a difficult month. The market will now shift its fundamental attention towards US employment numbers, starting with ADP this morning.

Bernanke is solely to blame for instigating ‘Turnaround Tuesday’. In his congressional testimony yesterday he did not say anything to scare the market. He was prudently efficient and forthright and not overtly cheerful about the state of the US economy. His dour understanding of the fundamentals led the market to understand that some large scale stimulus, or so called quantitative easing, was still in the Fed’s arsenal. The last easing program, QE2, diluted the dollar and his comments yesterday opened the door to a QE3 program being implemented. The combination of lower inflation and the possibility of taking ‘further’ action permitted the dollar to give back a chunk of this week’s gains. Traders have been given the green light and appear to be pricing in QE3, for months it had been the subject of a whisper campaign. At the end of the day, global markets remain fixated on Europe’s debt crisis. A Euro resolution is needed as US equities continue to flirt with ‘bear territory’.

The dollars is higher against the EUR -0.30%, GBP -0.20%, CHF -0.61% and lower against JPY +0.14%. The commodity currencies are weaker this morning, CAD -0.20% and AUD -0.16%.

The loonie is down nearly-3% in the last six trading sessions and walks hand in hand with weaker commodity prices, especially crude. While the market looks at technicals and fixates on potential recession fears, has been able to push the CAD to print new 13-month low outright yesterday. In this trading environment, every pull back is deemed a good buying opportunity. One gets the impression that commodity currency were probably looking towards some coordinated G20 intervention for support, this now been nixed by Canada’s Finance Minister who stated nothing was in the works. Perhaps now commodity currencies will place their bets on QE3 or a Euro-zone package for help.

In 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 (1.0540).

The AUD was unable to handle a higher-than-expected retail sales number (+0.6%) in the O/N session. The headline print cooled market expectations of a rate cut in the very near-term. However, the better than expected print, gave macro funds the opportunity to unwind their positions funded in the yen at more advantageous rates. It seems that investors and speculators are liquidating long positions in the Aussie at a record pace, adding that the ‘underlying flow trend among long-term players has turned decidedly negative’.

Earlier this week, the RBA hinted at rate cuts, despite Governor Stevens leaving key rates unchanged Sunday at +4.75%. The Bank communiqué was very cautious on the outlook, leaving the door open for easing. 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 (0.9551).

Crude is higher in the O/N session ($77.70 up+$2.03c). Oil price at one point yesterday fell-2%, their lowest price in 13-months, on increasing worry that Greece will default on debt and that global economic slowdown will curb demand for oil and other commodities. With Euro finance ministers considering opening the bond haircut debate and the EU postponing aid payment to Athens seem to be bringing a head to this Euro crisis and are expected to pressurize commodities on rallies. 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 technicaal selling on some of these rallies.

Gold prices did what they had been doing last month when investors required cash for margin purposes and that was trader lower. The commodity surrendered its early gains yesterday as it was caught up in hefty losses across all asset classes due to heightened concerns over the prospect of a Greek default. After last months rout, investors remain very cautious. For most of this week, the commodity had risen on safe haven reasons despite the dollar also rising. Yesterday, they both happened to lose, the dollar on the back of potential QE3 implementation and gold the loser as global bourses tackled ‘bear’ territory.

In the last two weeks, the yellow metal 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 expected to support the market. Under normal conditions, the Indian festival season helps drive buying from 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 in theory. With investors requiring margin cash is another phenomena ($1,608 down-$7.40c).

The Nikkei closed at 8,392 down-73. The DAX index in Europe was at 5,322 up+105; the FTSE (UK) currently is 5,030 up+87. The early call for the open of key US indices is higher. The US 10-year backed up +7bp yesterday (1.84%) and is little changed this morning.

Longer term maturities backed up from the lowest yields in two years after Ben testified in congress that the Fed has more ammunition in their arsenal and would implement it if need be to boost the US economy.

Under Operation Twist, the Fed concentrated in the middle of the curve, buying +$4.59b of debt due from November 2019 to August 2021. Long dated securities should remain under pressure as investors flatten the US yield curve now that the Fed has begun buying out the curve and selling shorter maturities. Investor’s fearing that the US unemployment report could again creep higher later this week will attract the buying of treasuries on these pull backs. In a low growth and deflationary environment coupled with policy maker’s accommodative positions could keep global rates low for years.

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