BRIC came, saw, and gave us hot air!

The BRIC contingent came, saw and delivered ‘mild’ provocative remarks. Capital markets were waiting to do battle! They blew in and out of town and now our attention turns to next week’s upcoming FOMC meeting. After last week’s G8 rendezvous, where all members, apart from Geithner and his ‘ostrich’ affliction he suffers from, commented on exit procedures for each country. Now, the market expects, in one-form or another, guidance on how the US Government and Fed will plan an exit strategy if and when the economy normalizes. Any formulation will have a huge impact on these FX markets. Dealers with positions, start your engines!

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

Forex heatmap

Yesterday’s US housing starts and building permits both surprised to the upside. Starts advanced more than expected last month (+532k vs. +454k), the highest level in 2-months. Even though this is a positive headline, some analysts are concerned going forward. Firstly, mortgage rates may rise as US bond yields move higher. Secondly, builder confidence fell this month and remains quite low, which would suggest that growth in housing starts, could remain ‘soft’ with inventory levels at record highs. Thirdly and most importantly, household balance sheets and disposable income scenarios remain distressed amidst tight credit conditions and a weak labor environment. Given this, even though housing affordability has increased due to tax-incentives and lower house prices, demand for new and even existing homes will likely remain weak. It’s still expected that prices could fall another 15-20%! Digging deeper into the reports, multi-family starts accounted for most of the +60% gain, although single-family starts did jump +7.5% m/m (the strongest gain in 3-years). It’s worth noting that housing permits also registered a stronger print, +4%, m/m, the 1st-gain in 2-months.

Also yesterday, lower food prices led to a moderate gain in US PPI despite higher energy prices (+0.2% vs. +0.3%, m/m, -5.0% vs. -3.7%, y/y). Because of the record high commodity prices this time last year, on a year-over-year scenario, the headline PPI has had the largest decline in 50-years! But, with commodities seeming to be finding a firm footing of late, it’s expected that PPI will gradually move higher going forth. Inflation should remain somewhat muted as core-PPI (ex-food and energy) actually fell -0.1% vs. +0.1% (this is also the first decline in 3-years).

Finally, it was not surprising to see that US industrial production contracted for the 7th-consecutive month yesterday (-1.1% vs. -0.7%). The weakness remains broad-based, and with companies continuing to reduce their inventory levels, one should expect demand for new inventories to remain soft and by default giving us an 8th an 9th consecutive month of weakness! Capacity utilization fell to a new record low last month (+68.3% vs. +69.0) as economic growth remains fragile.

The USD$ currently is lower against the EUR +0.49%, CHF +0.23% and higher against GBP -0.17% and JPY -0.05%. The commodity currencies are stronger this morning, CAD +0.29% and AUD +0.23%. The loonie remained close to home yesterday after tumbling the day before to new monthly lows, and all this despite commodity prices rallying! Canadian fundamental data showed that labor productivity rose by the most in 2-years yesterday (+0.3% vs. -0.1%, q/q). This was on the back of number of hours worked falling more than real-GDP in the 1st Q, which lead to the gain. It’s worth noting that some analysts agree, while a gain in productivity is a positive, especially during a recession, it is unclear whether it is sustainable given the huge volatility over the past year. It was only last weekend did the market start to utter the words ‘Cbank intervention’ for commodity currencies as they have run rampant of late vs. the USD! The loonie managed to weaken against all of the 16 most traded currencies as investor appetite for risk eased and equities traded heavily once again. If one believes that green shoot economics is very much in play, then technically the market is giving CAD bulls an opportunity to re-load they long positions before the currency once again makes an assault towards parity vs. its largest trading partner. However, dealers continue to sell CAD on USD pull backs in this environment.

In the O/N session the AUD was capable of rebounding from its 3-week low as Japanese equities rallied encouraging speculators to buy higher yielding assets. However, the decline in North American equities will surely encourage dealers to sell into these rallies. Despite stronger fundamentals all commodity currencies are been driven by the direction of global equities. Expect the AUD to once again come under renewed pressure this morning (0.7929).

Crude is lower in the O/N session ($70.22 down -25c). Both oil and gas ‘surged’ temporarily to an 8-month high yesterday as the USD weakened against the EUR, boosting the appeal of commodities as an alternative investment. With equities ending the day in the red, oil managed to pare most of its earlier gains. The USD has weakened on the back of BRIC countries contemplating reducing their dependency on the ‘mighty greenback’. This market is all about the negative correlation of commodities and the USD’s movements. Some ‘bold’ analysts believe that once the black-stuff is able to penetrate the $79 a barrel, and a summer target of $93 is on the horizon. This obviously would please OPEC immensely, who next meet in Sept. to discuss how world economies are coping with their 77% production cuts that have been in effect since late last year. Last week’s API report revealed that US stockpiles dropped, w/w (-6m barrels vs. +0.4k expected rise), as refiners ramped up production, couple this with the EIA raising its 2009 demand forecast for the 1st-time since Sept. has the market setting it sights on the $75 price that OPEC members wishfully predicted earlier in the month. The weekly EIA report also supported the API’s earlier findings. Inventories of oil dropped -4.38m barrels to +361.6m, w/w. Gas stocks declined for a 7th consecutive week, another bearish indicator telling us that production levels are much lower than we originally perceived. This morning inventory numbers are expected to show another weekly draw-down. A similar story with the ‘yellow metal’ who’s prices managed to rally the most in over a week as the dollar weakened, this increased the demand for the metal as an alternative investment ($934). Already this morning has the greenbacks actions have been able to pare some of the earlier losses.

The Nikkei closed 9,840 up +88. The DAX index in Europe was at 4,839 down -51; the FTSE (UK) currently is 4,292 down -36. The early call for the open of key US indices is lower. The 10-year Treasury’s eased 2bp yesterday (3.69%) and are little changed in the O/N session. As expected yesterday, dealers once again managed to make the Fed pay up for the $6.5b May-2012’s to Nov-2013’s buy-back. Treasuries remain better bid on pull backs at the moment, as equities see red and this morning and the Fed will once again entertain another buy-back (May-2016’s to May-2019’s).

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