The USD reigns supreme?

Our worst fears of Tier 1 financial failures coming to fruition remains front and center in the Capital Markets, even outpacing global concerns of ‘another cold war’ happening. The greenback had lost some of its technical luster yesterday. Is the market giving us another opportunity to own it again?

The US$ is stronger in the O/N trading session. Currently it is higher against 14 of the 16 most actively traded currencies in ‘whippy’ trading range.

FX Heatmap August 20th, 2008

Yesterday, US PPI jumped more than expected last month, up +1.2% vs. consensus expectations of a +0.6% advance. Core-PPI, (ex food and energy) rose by +0.7% vs. a +0.2% expectation in July. Market reaction expects the headline ‘pop’ to get discounted (someone should convince Fisher). The headline was slower than the previous months (+1.8%), but probably more disturbing for the Fed was the spike in core compared to the prior month’s +0.2% print. Analysts explained away the spike believing that lagged effects of energy prices sparked much of the gain. Residential gas spiked higher by +8.8%, and electricity prices were up by +2%. But, the collapse in natural gas prices over the past month combined with the lower overall energy prices, would expect future headlines to soften in coming months. Auto price hikes also drove the gains. It worth noting that the higher the car companies push prices, eventually their sales will decline as the current economic environment cannot support their business model, another failed attempt to pad the bottom line temporarily.

No big surprise in the US housing numbers. The surge in housing starts in June was indeed temporary (New York building code), as starts last month dropped to +965k (-11.0%, m/m- the lowest level in nearly two decades). Both single and multi-family starts declined, along with permits which fell -17.7%, m/m (+0.94m vs. +1.14m), and providing fresh evidence that we have not witnessed the end of the housing downturn in the US. Inventory levels continue to rise and are expected to provide ongoing pressure to house prices.

A hawker’s hawk, Dallas Fed Fisher, who has dissented at every Fed meeting this year in favor of a less accommodative monetary policy (2.00%), remains pessimistic. Inflation is his pet peeve and yesterdays US data provides him stronger evidence. He expects the US economy to face a continual rise in inflation as higher food and energy prices prompt companies to pass on these cost increases. On record yesterday, he believes that the US is ‘in the midst of a fierce correction’ and is convinced that US growth will ‘halt to a snails pace’ if not ‘to a complete halt by year end’. Yesterday’s data gives the Fed little latitude to cut interest rates and revive faltering economic growth.

The US$ currently is higher against the EUR -0.27%, GBP -0.43%, CHF -0.49% and JPY -0.44%. The commodity currencies are weaker this morning, CAD -0.34% and AUD -0.10%. Yesterday Canadian wholesale trade grew much faster than expected for June (+2% vs. an expected +0.7% jump). Taking price effects into consideration, the headline was still stronger than expected (+1% real gain) which will support real GDP growth. Digging deeper, a strong demand for autos accounted for much of the gain (it had fallen 5 out of the last 6-months). But, it’s worth noting that ex-autos trade only advanced +0.4%. Not surprisingly inventories also grew rapidly, with a +1.2% overall gain and +1.1% gain ex-autos. Analysts believe that this will pose a risk to future wholesale gains, as wholesalers attempt to work off the excess. Stronger economic data of late has provided support for the CAD$. Canadian fundamentals remain the strongest amongst the G8 members, but, traders are weary of its strong correlation with commodity prices which may eventually hinder its advance if commodities remain under pressure. The loonie did not initially find support from the data, but from the greenback and its association with deepening US financials write-downs. Expect traders to be better buyers on pull backs in the short term.

The RBA said that they may cut rates for the first time in 7-years to avoid a ‘deeper and more persistent’ economic slowdown (7.25%). Stronger commodity prices are not lending enough support as growth concerns prevail (0.8704). Expect better selling on AUD rallies for now.

Crude is higher O/N ($114.97 up +40c). Crude prices found some new found love as the US$ struggled vs. the EUR yesterday. Initially, the storm related premium was unable to find much traction. The market quickly priced out the premium when Tropical Storm Fay was forecasted to miss rigs and platforms in the Gulf of Mexico. The strong correlation between commodities and the greenback remains in tact. Recent global economic indicators indicate that demand conditions are expected to be weaker for the next 6-9 months, a major concern for OPEC, who meet in Vienna in a couple of weeks. Iran’s oil governor insists that the current market is oversupplied by +1m bpd, and the only option open to them is to decrease production. OPEC sees global oil demand averaging +89.9m bpd and demand next year rising to +87.8m. It seems that the world is potentially awash with the ‘black stuff’. The drop in demand can be attributed to slowing global demand growth and oil coming into the market from newly developed fields from non-OPEC member nations. In just over a month crude prices have pared 23% of its value from its historical highs. Traders continue to speculate that fuel consumption declines in the US will spread to other global economies as growth stalls. But, concerns over this morning’s EIA report showing inventory levels dropping w/w has provided an excuse for the market to purchase the ‘black stuff’ for now. Gold traders were caught in two minds yesterday, some speculated that higher US producer costs could influence the Fed to hike rates by year end (2.00%), thus eroding the ‘yellow metal’s’ appeal as an alternative investment. Others wanted the precious metal once the US$ came under pressure.

The Nikkei closed at 12,851 down -13. The DAX index in Europe was at 6,306 up +24; the FTSE (UK) currently is 5,357 up +37. The early call for the open of key US indices is lower. Yields of the US 10-year notes eased 1bp yesterday (3.80%) and backed up 2bp O/N (3.82%). The front end of the FI curve remains better bid on concerns that financial firms face widening losses from credit markets and the US housing slump. With potential deeper write downs by various institutions had investors seeking the safety of the debt market, and pushing yields once again to monthly lows.

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