ECB and BOE will dominate Forex.

It does not matter what the ECB or BOE will do this morning, or if NFP is worse than consensus tomorrow. Millions will be made and lost, but, for the foreseeable future the global economy remains under extreme pressure albeit due to growth or inflationary concerns. Global consumer confidence continues to take a battering and analysts believe that CBankers will follow the conservative approach and hold rates steady once again.

The US$ is weaker in the O/N trading session. Currently it is lower against 11 of the 16 most actively traded currencies in a ‘whippy’ trading range.

FX Heatmap September 4th, 2008

Data did not provide too many surprises yesterday. US factory orders rose more than expected for July (+1.3% vs. +1.0%), suggesting that US exports kept afloat the economy at the start of 3rd Q (the cheaper greenback also helped nicely). Factory orders is one of the few bright spots in the economy, but, going forward, with what the market has experienced over the past two months, analysts will have us believe that the rapid strength of the greenback is to finally weigh on future data. The infamous ‘Beige Book’ reported that consumer spending was ‘slow’ in most of the 12 Fed districts as the housing market ‘weakened’. This scenario will remain with us for some time, but, all districts reported pressure to raise prices because of higher commodity costs (last months commodity collapse will appease Bernanke and Co. for now). With the economy weakening under the impact of the financial and housing debacle, the market seems to be quite happily pricing in no change by the Fed until the New Year (2.00%).

The general market sentiment is that the BOE will cut rates by year-end (5.00%) and that there is no need to shift towards an ‘accommodative policy’ at today’s meeting, despite consumer confidence remaining at record lows (+52 vs. +93 y/y-last month). Policy makers believe that inflation is expected to reach its peak in Aug/Sept. (at around 5%) and governor King will want to see a few weeks of a decline in inflation before assuming a dovish tone. Last months inflation report indicated that the MPC will be focusing on their medium term objectives and not the volatile short term objectives. The report also expects a substantial ‘undershoot’ of inflation targets in 18-months time. Thus this inflation profile coupled with increasing downward risks for growth encourages cutting rates by year end. Unlike the ECB, who are more transparent than most CBankers, they too are expected to stand pat and keep rates on hold at 4.25%, despite the clear signs of a deeper economic slowdown (anticipated to be more widespread than in the US). Price stability remains the main concern for policymakers. The current level of inflation coupled with risks of second-round effects, will be the reason behind their decision to keep rates unchanged in the coming months. There are no signs of moderation in wage pressure and risks for price stability remain an issue. The ECB has been very focused on the wage/inflation scenario. On should expect policy makers to witness emphatic signs of ‘decelerating inflation’ risks before considering the removal of ‘any’ monetary tightening. As per usual, all markets will be focused on Trichet press conference.

The US$ currently is lower against the EUR +0.17%, GBP +0.39%, CHF +0.32% and higher against JPY -0.08%. The commodity currencies are stronger this morning, CAD +0.53% and AUD +0.20%. No surprises from the BOC rate announcement yesterday, but, the market was definitely caught off side on how aggressive the loonie rallied after Governor Carney kept O/N lending rates on hold at 3.00%. Rates remain ‘appropriately accommodative’ amid slower than expected economic growth. In his following communiqué, Carney said that ‘economic activity was slightly lower than expected’ but noted that it is still close to the economy’s production capacity (inflation jumped to 3.4% in July, outside their 1- 3% target range). They also commented on the CPI, which they do not expect to spike as high as they initially anticipated due to lower energy costs. They expect inflation to slow to their desired 2% target by next year. The overall market sentiment has us believing that the statement was a tad dovish, but, not as dovish as investors would have liked, hence the rally in the CAD. With plummeting commodity prices expect the currency to once again come under some renewed pressure, traders for the time being are better buyers of USD’s on pull backs.

The AUD has taken itself off the floor in the O/N trading session after printing yearly lows vs. the greenback yesterday (0.8375). Despite wobbly commodity prices, speculators have been confident to step up to the plate and covet higher yielding assets like the AUD. Australian fundamentals remain weak, O/N a government report showed the trade balance unexpectedly turned to a deficit in July, as oil imports jumped and exports fell (-0.7b vs. +0.4b). All eyes will monitor commodities.

Crude is higher O/N ($110.10 up +75c). Fact is always better to digest than rumor. Hurricane or Tropical Storm Gustav has spared the Gulf of Mexico and New Orleans the vast destruction that was witnessed by the region three years ago (Katrina and Rita). One energy company after another declared yesterday that their oil platforms were spared of any significant damage which continued to add pressure to commodity prices. So far this week, the black stuff has lost close to 6% of its value; the strength of the greenback has also contributed. Oil led the charge lower and managed to print a 5-month earlier in the week. But, futures traders are conscious of other hurricanes brewing and this downward spiral cannot be sustainable during this hurricane season. The optimist would expect oil to retreat towards that $90 a barrel but only for Ike, Hanna and Josephine. The overall market strength of the greenback has indeed contributed, but the fact remains, investors are loosing their appetite for the black stuff. Prior to hitting land this past weekend, petroleum companies halted 96% of offshore oil production in the Gulf and limited their refinery capacity in preparation for the storm. With demand weakening and abundance of the black stuff of late, energy traders will continue to be better sellers of futures on rallies at the moment. But, do not be surprised to experience the whiplash effect to remain in vogue after what we experienced before Gustav made land. This morning we have the IEA inventory report, always an eye opener. Gold has remained under constant pressure this week on the back of spiraling energy costs coupled with a strengthening greenback reducing the demand for the ‘yellow metal’ as a hedge against inflation. But, during this morning’s London session with the ‘big dollar’ under pressure, renewed interest to own the commodity was seen ($816).

The Nikkei closed at 12,557 down -131. The DAX index in Europe was at 6,406 down -61; the FTSE (UK) currently is 5,516 up +16. The early call for the open of key US indices is lower. Yields of the US 10-year note eased 3bp yesterday (3.71%) and are little changed O/N. Treasuries have aggressively rallied this week and printed 4-monthly lows as falling commodity prices have eased the ‘inflation speculation theory’. This has led to the increased demand by investors for longer term government debt. With equities failing to gain any traction also has investors seeking the sanctuary of the FI market.

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