Further Financial Fallout’s dominate Forex!

Cbanks will need to oil and dust off their ‘Gutenberg printing presses’, so that they can keep up with cash demand (FED, BOJ, ECB and BOC). Global policy makers are busily injecting funds to stem the financial crisis. The ‘cockroach theory’ continues to rattle consumer confidence and aiding ‘risk aversion trading’. All this as Bernanke favors ‘target loans’ over interest rate cuts.

The US$ is weaker in the O/N trading session. Currently it is lower against 10 of the 16 most actively traded currencies in another ‘whippy’ trading range.

FX Heatmap September 18th, 2008

Further evidence yesterday proves that the US housing markets continue to retreat. Some analysts hoped and prayed that that the housing markets may have hit bottom already. The balloon remains deflated as a new low on housing starts was achieved last month. Only +895k new homes were under construction vs. +940k, m/m. Realists do not expect a material improvement anytime soon. Despite US mortgage rates easing on the back of tighter GSE spreads after Paulson’s rescue plan. The market has offset this by ‘tighter loan term agreements’ being implemented. Hoarding of cash coupled with interbank funding pressures can only make it tougher for potential consumers to access credit. Other US data faired no better, US housing permits fell in Aug. (2nd consecutive month), as builders continue to scale back activity due to reduced demand and a large inventory buildup (+854k permits, down -8.9% m/m from July). This is the lowest level in 18-years as both single and multi-units construction declined. With banks remaining fearful of further bankruptcies, one can expect borrowing costs to remain elevated. The net effect should have mortgage regulations tighten further, thus reducing housing affordability and the number of homebuyers on the market and lengthen the recovery period for this housing debacle.

Bernanke has chosen the route of cash injections and foregone interest rate manipulation. To date, the Fed has managed liquidity injections via swapping out Treasuries for riskier assets pledged as collateral. But now, Treasury is issuing more (Issuance of 40b 1-month bills) for the express purpose of floating balance sheet expansion at the Fed (the reserves have become depleted). Seeking more may be a sign that Bernanke and Co. expects financial market volatility to require massive intervention for a long time yet. This action will directly impact the inflation question. They are uncertain about the trade-off between monetizing debts in their balance sheet expansion vs. the potentially ‘deflationary forces of asset price declines’ (pressurizing global growth even further). Uncertainty over how these forces may interact may well explain why the Fed remained concerned for the outlook of inflation in their communiqué this week. Stagflation scenario remains intact!

The US$ currently is lower against the EUR +0.52%, GBP +0.16%, CHF +0.15% and higher against JPY -0.15%. The commodity currencies are stronger this morning, CAD +0.98% and AUD +1.57%. The loonie has struggled as ‘risk aversion’ trading strategies dominated the FX market. Heightened investors concerns about global growth have had a negative effect on commodity currencies. Finally, in the O/N sessions commodity currencies have caught up with yesterdays rampant commodity price rise. Canadian data showed that foreigners decreased their holdings of Canadian securities (bonds and stocks) in July, -5.6b vs. +7.3b (first time this year). Prior to Cbanks ‘cash injection’ the loonie found no love amongst investors as market volatility dissuaded speculators from owning riskier assets. Global perception has analysts adjusting the loonies’ year end price vs. the greenback to 1.1000. Canada has become guilty by its ‘proximity and association’ with its southern neighbor. Fears of further financial meltdowns and stagnating global growth could add to the loonies’ demise in the short term. The US remains Canada’s largest export market, over 75% of our exports head south and 50% of that is commodity based. With global growth issues a major concern, commodity prices will continue to drag on the Canadian economy going forward. Expect traders to be better buyers of US$ on pull backs as Canadian economic data remains on the softer side. 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 found some deserving support on the back of elevated commodity prices yesterday. But, traders expect the currency to continue to trade under pressure, especially vs. the JPY, as investors are willing to unwind recent carry trades and enter into ‘risk aversion’ deals. The high yielding assets of the Kiwi and AUD$ are considered a pair of the riskiest. Expect rallies to be sold for now (0.8046).

Crude is lower O/N ($96.47 down -69c). Oil aggressively advanced yesterday, a day after the Fed stepped in to provide a loan bridge to AIG. This is an institution that the Fed could not allow to fail. Investors sought the safety of the commodities on concern that the credit crisis will deepen, leading more financial institutions to fail. The market still clings to the idea that the ongoing financial turmoil may weaken the global economy and reduce demand even further. Investors fear that a further deterioration of the US financial system will spread to the real economy and affect demand for oil. Fundamentally commodity prices have the potential of falling much further. To date, oil has depreciated 38% from the highs printed 2-months ago. OPEC (who supply more than 40% of the world’s crude), have lowered their forecast for 2009 oil demand to 87m barrels a day because of the global economic slowdown. Analysts are now predicting that they will ‘step in’ and take action if price pressure push crude towards $80 a barrel. Market consensus has us believing that OPEC is content with $90-$100 a barrel. Yesterday’s EIA report showed that US crude inventories fell -6.33m barrels vs. -3.5m to 291.7m, w/w. It was the 4th straight inventory decline. Fuel demand averaged +19.9m barrels a day over the past month (-4.4%, y/y), while gas consumption averaged +9.21m barrels a day (-2.6%, y/y). Gas stocks declined -3.31m barrels to 184.6m (the lowest level in nearly 20-years). With refineries due to come back on line in the Gulf of Mexico, speculators will once again be focusing on demand levels and not inventory. This may lead to another squeeze lower! There was no stopping gold price’s yesterday. It advanced the most in 8-years ($879), as investors sought the safety of the ‘yellow metal’ on concerns that the credit crisis will deepen, thus leading to more financial institutions failing.

The Nikkei closed at 11,342 down -407. The DAX index in Europe was at 5,875 up +15; the FTSE (UK) currently is 4,795 up +63. The early call for the open of key US indices is higher. 10-year Treasury yields eased 6bp yesterday (3.42%) and are little changed O/N. With the loss of confidence in the treasury market spreading, it has managed to push short tem yields (especially the Bill market) to their lowest levels in half a century. Investors are concerned that that credit market losses will widen after the bankruptcy of Lehman Brothers and the Fed’s takeover of AIG. With Financial institutions hoarding cash, traders are seeking ‘safer capital’ and seem to be relinquishing returns and paying for the privilege of knowing their money is safe. Expect the Fed to increase short term bill issuance (40b 1-month, similar to cash management). So far this week Cbanks have injected $300b into the financial system to ease credit market concerns. Money printing presses do not seem to be working fast enough. Conspiracy theorists do not see the Fed’s bridge loan to AIG as a permanent solution, but, a temporary ‘stop gap’. Expect market nervousness to continue to provide an undertone bid for the FI asset class.

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