Trichet Exits on a Low Note

Higher than expected Euro inflation numbers last week should prevent, the departing Trichet from overseeing an ECB rate cut this morning. The market expects policy makers to extend the provision of the unlimited, fixed-rate funding timeframe into next year, providing a further six-month LTRO, with an outside possibility that a one-year LTRO is also announced.

The futures odds are 50% for a rate cut. Despite the bumbling cohesive actions of policy makers since they took ‘real’ ownership of Euro sovereign concerns this week, if the ECB disappoints and leaves rates unchanged, markets are likely to increase their pricing of default risk. The whiplash effect will rid most of this weeks risk earnings and again promote the dollar and yen strength.

An ease would likely support risk currencies more than the EUR itself. An aggressive ECB cut would not directly address the underlying drivers of European stress.The market will be looking further afield for larger returns, their focus will be the periphery of the G10 and emerging markets against both the USD and the EUR.

On the other hand, any easing or strong dovish overtures that promotes risk will provide the ideal opportunity to set oneself up nicely if you expect a disappointing NFP print tomorrow.

Forex heatmap

Forget the EU, IMF and Cbanks rhetoric for the moment and focus on fundamentals. The remainder of the week is about jobs and how the US employment landscape is changing or not. In the US yesterday, private businesses added more than expected jobs this month. Larger enterprises seemed to be cutting jobs as layoff announcements last month jumped to the highest prints in two-years. The ADP report recorded a +91k gain, an increase that had ‘a few’ analysts thinking of changing their NFP call a tad higher. Last month’s release was revised down by-2k to +89k. On the face of it, the report is treading water amongst the private sector category. Any NFP release includes Government helpers. Now that the ex-Verizon strikers are back to work, on the first go around, the market expects the employment report to create about +70k jobs and with this month’s unemployment rate to remain on hold at +9.1%.

The good news is that employment was positive in September, the bad news, the US economy remains incapable of producing enough new jobs, approximately +125k, to offset population growth. The market tends to discount the ‘private jobs number’ as a good precursor to Friday’s jobless report.

Business conditions in the US non-manufacturing sector were little changed month-over-month (53 vs. 53.3). In the sub-components, employment fell and price pressures eased. Digging deeper, last months new-orders index rose to 56.5 and is in stark contrast to ISM-manufacturing report earlier in the week that revealed a contractionary reading of 49.6. The non-manufacturing report shows the business activity index rising to 57.1 while the employment index fell into contractionary territory, easing to 48.7 from 51.6. This print certainly tells a different tale about employment. The pieces for NFP continue to come together. Finally, price pressures eased, with the index decreasing to 51.9.

The dollar is lower against the EUR +0.23%, GBP +0.18% and JPY +0.11% and higher against the CHF -0.02%. The commodity currencies are stronger this morning, CAD +0.27% and AUD +0.87%.

Are USD bulls entering the reload and lock territory? So far this week CAD traders have had little of their own fundamental data to chew on. Nearly all the currency’s move has been at the mercy of its largest trading partner south of the boarder. In a risk aversion trading environment, the loonie, a commodity and interest rate sensitive currency, movements generally become over extended in one direction or another. A better-than-expected US employment report and some progress on the European debt crisis yesterday boosted risk appetite and gave commodities a lift, allowing the loonie to back away from its 13-month lows rather nicely. However, the probability of a Greek default has been able to keep a lid on the CAD rally.

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 ahead of North American employment data tomorrow (1.0404).

The AUD has maintained its two day rally outright as Asian stocks extended a worldwide rally, increasing demand for higher-yielding assets. European official’s and policy makers are stumbling about and at long last seem to be stepping up and taking ownership of the European debt crisis. The market is expecting the ‘creation of a new Euro rescue plan that will be positive for risk’. For most of this week, it seems that investors and speculators have been liquidating long Aussie positions at a record pace, as the ‘underlying flow trend among long-term players had turned decidedly negative’ on the back of the Euro crisis.

On Monday, the RBA hinted at rate cuts, despite Governor Stevens leaving key rates unchanged 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 (0.9727).

Crude is higher in the O/N session ($80.89 up+$1.21c). Oil rose for a second day as shrinking US crude supplies, better-than-expected economic data and signs Europe can control its debt crisis lessened concerns that fuel consumption will suffer.

The weekly EIA report showed that the US commercial crude inventories decreased by -4.7m barrels from the previous week. At +336.3m barrels, oil inventories are above the upper limit of the average range for this time of year. Total motor gas inventories decreased by -1.1m barrels are above their upper limit of the average range. Analysts were expecting crude gain by +2.5m barrels and gas stocks to move up by +1.30m barrels last week. Oil refinery inputs averaged +15.1m barrels per day during the week, which were +73k barrels per day below the previous week’s average as refineries operated at +87.7% of their operable capacity.

The old support levels now become the new key resistance points. 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 technical 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 from the previous evening due to heightened concerns over the prospect of a Greek default.

After last months rout, investors remain very cautious about this trade. For most of this week, the commodity had risen on safe haven reasons despite the dollar also rising. With asset class’s toing and froing, investors have been deliberating over whether bullion is a shelter from turmoil or a speculative trade that will rise with riskier assets.

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 phenomenon ($1,652 up+$10.40c).

The Nikkei closed at 8,522 up+139. The DAX index in Europe was at 5,597 up+124; the FTSE (UK) currently is 5,190 up+88. The early call for the open of key US indices is higher. The US 10-year backed up +8bp yesterday (1.92%) and is little changed this morning.

Longer term maturities backed up from their lowest yields in two years after Ben’s testimony in congress stated that the Fed has more ammunition in their arsenal and would implement it if need be to boost the US economy. Investor optimism that European leaders are stepping up efforts to resolve the region’s debt crisis has sapped demand for the safest assets. Even yesterday’s surprisingly strong private US employment report is pressuring treasury products.

Price movements throughout the different asset classes yesterday are proof that a modest amount of risk appetite is beginning to return to the markets. Under Operation Twist, the Fed will purchases long dated securities financed by selling the short end, a program that provides no liquidity, but is expected to lower longer term rates and hopefully kick start growth again in a stagnant US economy.

Investor’s fearing that the US unemployment report could disappoint 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 should keep global rates low for years.

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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