Forex takes direction from Lehman!

With Lehman scrambling to find a ‘stronger financial partner’ without holding a true ‘fire-sale’ has equity and FI markets jockeying for position. Fears of wider credit market losses looming and lack of deep pocketed suitors is once again encouraging risk aversion trading.

The US$ is weaker in the O/N trading session. Currently it is lower against 13 of the 16 most actively traded currencies in another ‘volatile’ trading range.

Capital markets fear that economic growth in Euro-land will be slower that the US, had pushed the greenback to yearly highs vs. the EUR yesterday. Despite Trichet focusing on inflation, ECB policy makers will have to cut borrowing costs as some members head towards a deeper recession than previously thought. Overall risk aversion trading continues to support the greenback. In the O/N session the big dollar managed to give some of that up as equity markets rallied on renewed belief that Lehman would find a ‘white knight’. Investors have woken up from their ‘myopic’ state and are starting to focus on the rest of the world. The European Commission said earlier this week that the euro region’s economy will probably stagnate this quarter. Analysts are predicting that policy makers will cut borrowing costs by 25bp to 4.00% in the 1st Q of 2009.

The US labor market continues to weaken as the housing debacle filters into the broader economy. More Americans filed for unemployment insurance last week, as companies cut staff to maintain profits in a slowing economy. First-time jobless claims fell to +445k vs. a revised +451k. The number of continuing claims rose +122k to 3.525m (the highest in 5-years). The 4-week moving average (a less volatile picture) rose to +440k from +439.7k. The Labor Dept. remains non committal on whether or not the EUC program (emergency unemployment compensation which has inflated the data over the past 3-months) is still impacting the bottom line. They still will not give an estimate as to what the impact has been.

The US trade balance widened for the month of July (-62b vs. -56.8b). But, much of the increase can be attributed to the price of oil. Analysts expect a ‘partial reversal’ over the next couple of months as the price of oil has plunged over 31% since its highs. While there is every reason to expect export growth to eventually taper off due to a global slowdown, analysts are adamant that are no signs of it impacting the trade data just yet. Exports were up +3.3% m/m which translates into +20.1%, y/y. It is only a matter of time before the USD surge will begin to have an impact. Including revisions to previous months, yesterdays US data is significantly more dovish (the OIS market is pricing aggressively a Fed rate cut sooner rather than later). Import prices came in softer than expected (-3.7% vs. -1.6%). This has to be music to Bernankes ears as it deflates the hawk’s egos!

The US$ currently is lower against the EUR +0.82%, GBP +0.76%, CHF +0.33% and higher against JPY -0.34%. The commodity currencies are stronger this morning, CAD +0.76% and AUD +0.48%. The loonie finally broke out of its tight weekly trading range as Canadian data came in below expectation yesterday. The trade surplus declined to +$4.9b in July from a revised +$5.6b surplus in June. Total imports rose faster than exports, as consumer spending remains buoyant despite the weakening economy. The decline also reflects falling commodity prices, suggesting we will see further softening in the trade surplus in future data as oil has declined 31% over the past two months. The real trade balance also deteriorated further, subtracting from real GDP in July and falling to -$3.5b. New home prices continued to moderate in July, by default putting further downward pressure on core inflation (rose as expected by +0.1% m/m, bringing the y/y rate down to +2.7%). Slower global growth will mean lower commodity prices. Over 50% of Canada total exports are commodity based. The currency has lost 6.5% of its value since oil’s registered its highs 2-months ago. Expect traders to continue to be better buyers of the greenback on pull backs. Politically and economically Canada will be pre-occupied with its general election slated for Oct 14th over the next few weeks.

The AUD and NZD appreciated last right as Asian equities rallied, increasing investors’ appetite for higher-yielding assets for now. The possibility of Lehman finding a buyer has stabilized the market and risk appetite continues to build.

Crude is higher O/N ($102.23 down -23c). Hurricane Ike is building up strength and heading towards the Texas coast where the US refines 26% of its oil production. This has caused oil prices to fall while gas prices rise. With refineries out of commission crude stocks will build up. Analysts have noted that Gulf operators have evacuated personnel from 63% of production platforms. It’s estimated that 96% of Gulf oil production, and 73.1% of natural gas output, is shut (approximately +1.25m barrels a day and +5.4b cubic feet a day of gas). Earlier this week OPEC President Khelil called on members to stop producing more than the group’s set quota, a move that would reduce supplies by +520k barrels a day. They are not cutting ‘production’; they are cutting ‘over-production’. They intend to reduce a ‘huge oversupply’ of oil on the market, and at the same time psychologically provide an artificial floor for the black stuffs price ($80-$100). The Saudis are not planning to reduce its own oil production, they intend to supply whatever customers demand. Higher oil prices continue to hurt the global economy, despite oil prices retreating 31% from their highs printed 2-months ago. This weeks EIA report showed that fuel demand declined w/w and refinery production dropped after Hurricane Gustav shut plants along the Gulf Coast. These plants remain closed as Hurricane Ike moves into the Gulf of Mexico. Operating rates fell to 78.3% last week, the lowest levels in three years. Whilst crude stocks declined -5.8m barrels to 298m, it’s the crude production levels that will continue to weigh on prices. So weather watching will remain the order of the day. Hurricane Ike is predicted to hit land at 2am Saturday morning. Gold finally has found some traction ($758) as energy costs rise and a weaker greenback has increased the demand for the ‘yellow metal’ as a hedge against inflation.

The Nikkei closed at 12,214 up +112. The DAX index in Europe was at 6,247 up +69; the FTSE (UK) currently is 5,397 up +79. The early call for the open of key US indices is higher. 10-year Treasury yields eased 4bp yesterday (3.58%) and have backed up 8bp in the O/N session (3.68%). Yesterday, Treasury prices rallied once again as traders speculated that Lehman Brothers will collapse due to a shortage of capital, thus increasing the demand for the safety of government debt. Advancing equities has reduced this demand O/N. But, widening financial-market concerns continue to provide an undertone bid. US OIS (overnight index swaps) are aggressively pricing in a Fed rate cut (2.00%) sooner rather than later.

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