Bernanke ‘stands and delivers’ or does he?

The greasing of the Credit market wheels has investors renewing their relationship with risk. Ben delivered, the world embraced and but US investors managed to sell equities in record time (down falls -400 in 13 mins-15-mins before bell). Large month end and year end requirements will have Fund traders causing all sorts of volatility in various Capital classes over the next two days. ‘Perception and reality’ are two different things!

The US$ is weaker in the O/N trading session. Currently it is lower against 14 of the 16 most actively traded currencies, in another ‘volatile’ trading range.

FX Heatmap October 30th, 2008

Bernanke and Co. did not disappoint. They gave the market what they wanted, 1% borrowing costs (10-0 vote). They handsomely slashed O/N rates by the expected 50bp yesterday. Prior to the announcement the market did a good job paring back the recent US$ gains, recording some of the biggest moves vs. the G7 currencies in 10-years (for the loonie it was 4-decades). The Fed seeks to revive the US economy hit by a long list of problems stemming from the most severe financial crisis in decades and by default avert a global recession. The cut in the target funds rate is more of a symbolic gesture than a means for channeling meaningful amounts of stimulus. As expected, the statement language leans heavily in the direction of downside risks to growth, with no mention of upside risks to inflation. But, the committee believe that ‘the recent policy actions, coordinated global interest-rate cuts, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth’. Bernanke expects inflation to moderate in coming quarters to ‘levels consistent with price stability’ (this on the back of oil retreating 57%). The Fed has been aggressive in providing liquidity to ‘grease the wheels’ and it seems that investors are tentatively willing to take on some risk. Traders continue to be a seller of the recent bullish greenback and are happy to buy equities. Now it seems a foregone conclusion that both the ECB and BOE will follow suit next week.

Yesterday’s US durable goods orders surprised on the upside, but and a ‘big but’, most of it was due to strong aircraft and defense orders. Investors should not be fooled by the headline which showed a positive +0.8% jump in durable goods for Sep. (consensus anticipated a -1.1% reading). Core orders still fell by 1.1%, m/m and, if you take the revisions into account –Aug. core-orders were revised down to -4.1% from -3.0%, orders fell even further. Most analysts agree that this is only the beginning, as the global economy heads into a recession. One should expect the manufacturing sector to continue to come under further pressure in the months ahead, do not expect any bail out from the domestic consumer for some time. Let’s see what the preliminary GDP numbers have in store for us today.

The US$ currently is lower against the EUR +1.44%, GBP +1.35%, CHF +0.03% and higher against the JPY -0.90%. The commodity currencies are stronger this morning, CAD +1.70% and AUD +1.08%. Interest rate differentials, global equities, commodities and program selling (5-yds by Swiss names) propelled the loonie to a 6-cent range yesterday. The largest one day move in nearly 4-decades. The greenback fumbled against most of its major trading partners on the back of lower borrowing costs in the US. The magnitude of the loonie move caught most traders by surprise as many investors were caught in off side positions. The black-stuff advancing provided the strongest support, but program buying of CAD AUD GBP by one specific player in large amounts continued to underpin the market. Higher equity valuations across the globe are attracting better tolerance for risk, and there is a ray of optimism that global equities may be bottoming out. This can only bode well for the loonie in the short term. Too far, too fast is definitely a concern, traders see better levels to own the currency despite the strength of the one directional play. Now that the Fed eased 50bp, it’s anticipated that the BOC will need to extend interest-rate cuts (2.25%) in the face of slowing economic growth. Last week Governor Carney reduced overnight borrowing costs by 25bp (2.25%), less than the market had anticipated, but added that it will probably need to act again (Dec. 9th) to fend off the effects of a credit crisis and global recession (less than 2% by year end). The BOC MPR last week said that the global credit crisis will be ‘deeper, more persistent’ and more widespread than the policy makers had anticipated and signaled they will cut borrowing costs again as the economy teeters on the edge of a recession. Governor Carney said ‘that these financial headwinds will take time to dissipate, even with the extraordinary recent policy actions just announced’. Looks like a good bet that borrowing cost could break the 2% mark by year end.

Earlier this week the threat of intervention by the BOJ and the actual intervention by the RBA caused the AUD to appreciate. Some renewed fait in global equities saw investors seek higher yielding currencies. Currently the AUD$ risk appetite and equities go hand in hand, fundamentals are of no concern. Australia’s inflation rate may limit the RBA to cut borrowing costs as deeply as previously expected, which depending on how equities react may be short term positive for the currency (0.6758).

Crude is higher O/N ($69.08 up +158c). Crude remained better bid on signs that global credit markets are beginning to work and Cbanks slashing rates may help revive demand (China, Norway). Oil has managed to pick itself up off the floor and has rebound nicely from its 17-month low achieved earlier this week. Other variables have also provided some traction, global equities advancing and OPEC threatening to meet again before Dec. OPEC earlier this week indicated that they may call a new meeting if prices fail to react to the -1.5m barrel-a-day output cut it announced last week. The initial cut in production will commence on Nov. 1st. With the greenback paring recent gains has also contributed to commodities rise. Of late growth fears had outweighed any cut in production. OPEC still produces over 40% of the world’s oil, but there are doubts that they can cut much more, the members also need cash, just like most economies do. So do not be surprised to see some members not adhere to future cut quotas. The EIA report yesterday showed that US inventories of crude oil and distillate fuel rose last week. Crude oil stocks climbed +493k barrels to +311.9m barrels w/w vs. a +1.55m barrel gain. Distillate inventories rose +2.33m barrels to 126.6m barrels vs. an increase of +1.05m barrels. While gas stockpiles dropped -1.51m barrels to +195m, (1st decline in 5-weeks). Overall a bullish report as inventories rose less than anticipated. But, sluggish demand continues to be the catalyst for rising inventories. Gold continues it climb ($772) as the ‘greenback’ fell vs. the EUR, thus boosting demand for the ‘yellow metal’ as an alternative investment.

The Nikkei closed 9,029 up +817. The DAX index in Europe was at 4,923 up +114; the FTSE (UK) currently is 4,244 up +3. The early call for the open of key US indices is higher. The 10-year Treasury yields eased 5bp yesterday (3.85%) and another 5bp O/N (3.90%). Traders began cheapening up the US yield curve after officials indicated that the Governments funding needs are ‘unprecedented’. Medium to longer term debt finally managed to give up the most in 2-weeks as equities found some positive traction after the Fed ease. Global equities and some risk taking have FI underperforming. Expect traders to once again cheapen up the curve ahead of the 5-year auction this afternoon.

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