Russia is on the Offensive again!

The Euro-zone inflation rate fell to its lowest level in more than 2-years last month (1.6%), as oil prices plunged and consumer spending slumped. This will surely put the screws on Trichet to cut lending rates again. The wild move in FX-land is due somewhat to a dislocation in currency rates during the last days of the holiday period. Part of the rather massive move seems to be a ‘normalization’ given the efficient markets we suppose to have!

The US$ is stronger in the O/N trading session. Currently it is higher against 15 of the 16 most actively traded currencies, in another ‘volatile’ trading range.

President-elect Obama’s intended fiscal plans have lent enormous support for the greenback. Like a light switch being turned on, investors have clued into ECB (2.50%) and the BOE (2.00%) needing and willing to cut rates again over the next two weeks. This year has already started with an impressive move in Forex. Yesterday, we witnessed the EUR trading 5-different handles and it did not stop there in the O/N session either, several other crosses experienced similar volatility. There have been various reasons that have warranted the EUR to weaken, but to this extent so rapidly, not sure. For all the technically inclined, sub-1.3840 was an important chart point. For the fundamentalists we have Trichet and Co. most likely easing again next week. There was even market whispers about possible large EUR negative bond redemption and coupon flows (+$13.8beur coupon and +$14b redemption). Asian CB apparently had genuine selling interest, but, perhaps the most plausible reason was that Capital Markets needing to reverse the sometimes illogical moves that took place during the ‘illiquid’ holiday market. Historically, we have to hold onto our hats for the first few days of any New Year. Mind you this week’s unemployment report will be a sobering event according to President-elect Obama!

The US$ currently is higher against the EUR -1.11%, GBP -0.06%, JPY -0.32% and CHF -0.74%. The commodity currencies are weaker this morning, CAD -0.63% and AUD -0.99%. No fundamental data aided the loonies rise yesterday, commodities were mixed. Oil prices remain better bid while gold struggled as the greenback soared. Even negative headlines in the London Times yesterday could not de-rail this commodity influenced currency. The article commented on Canada’s oil sand industry and how it is ‘cooling’ rapidly. It is estimated that $72b worth of oil sands projects have been put on hold in the last 3-months, and concludes that oil sand extraction costs require oil at $70 a barrel vs. the sub- $50 we currently experiencing. Conclusion, this can only be negative for the currency in the medium term. Liquidity and lack of participation continues to influence rightly or wrongly the CAD value. In under a week we have witnessed EUR/CAD move from 1.74+ down to sub 1.6000. The ferocity and one directional move is very much overdone, but dealers have been hesitant to step in front of a runaway train at this moment. Later this week the mighty North American employment reports could once again be a dampener on the currency, but for now, the currency is very much riding the EUR weakness and USD strength coattails.

The AUD$ remains better bid on pull backs and in the O/N session recorder a 3-month high as the rally in global equities has increased the risk appetite for higher yielding assets. The currency has pared some of its gains as profit taking occurs. Robust commodity prices of late have also lent support to currencies down under. Traders continue to speculate that further global interest-rate cuts this week will revive investors’ risk appetite even more (0.7150).

Crude is higher O/N ($49.33 up +52c). Confidence in Obama’s stimulus package and the Geo-political issues especially in the Middle East have Crude prices remaining better bid so far this week. Investors are speculating that the conflict may disrupt crude supplies from other regions in the Middle East. Russia is once again reducing its gas supplies to Europe due to its ongoing price dispute with Ukraine. Crude has rallied 23% on the back of Middle East and European concerns. Last weeks weekly EIA report showed that inventories had gained less than anticipated allowing the non-holidaying dealers to push the illiquid market aggressively. US fuel consumption for 4-weeks on a y/y basis has fallen -3.7%. It was not fundamentals that push the black-stuff prices aggressively higher last week, but the lack of dealer participation. Both global equities and a heightened investor risk appetite lent much needed support to the commodity that pared 54% of its value last year. Analysts expect crude futures to remain better bid throughout this week as OPEC implements its record announced productions cuts. The Middle East tensions has provided support on deeper pull backs, as there remains concerns that supply from the world’s largest producing region may be disrupted. China last week publicly stated that they will supplement their ‘emergency’ oil reserves. This stockpiling mentality will negate some of the ‘demand destruction’ that we have witnessed from this global economic meltdown. OPEC’s cohesive support should provide further traction for commodities in the short term. Gold prices remain under pressure as the greenback rallies vs. the EUR, thus eroding the appeal of the ‘yellow metal’ as an alternative investment ($845). Expect heighten tensions in the Middle East to provide support on deeper pullbacks.

The Nikkei closed 9,080 up +37. The DAX index in Europe was at 5,044 up +67; the FTSE (UK) currently is 4,604 +25. The early call for the open of key US indices is higher. The 10-year Treasury yields backed up 6bp yesterday (2.49%) and are little changed in the O/N session. The long end of the US yield curve continues to loose traction as dealers cheapen up the curve ahead of the New Issues later this week. It is anticipated that the US government will issue another $50b of new debt to stave off a deeper recession. President elect Obama’s vision of stimulating their economy by pushing $300b worth of tax cuts will surely de-rail the one directional play of the FI market that we have witnessed during most of 2008.

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