Chinese Banks are falling into US financials acid tests traps

Cracks are appearing in the one directional equity market. The ‘disconnect’ amongst asset classes is now connecting! Stocks down, bond’s up and USD wanted. All this week, the US short term yield curve, experiencing record low yields, had been in demand despite the equity rally. Yesterday’s stronger US data was unable to push global bourses higher in the O/N session. Now that various financial bank statements are under the watchful eye of both Chinese and German authorities, it has given the ‘buck’ a lift, as investors reduce their risk appetite in this holiday shortened week. Chinese regulators are concerned that ‘unprecedented lending by banks has eroded their capital to dangerous levels to cushion asset quality erosion’. It sounds like a familiar tune!

The US$ is stronger in the O/N trading session. Currently it is higher against 14 of the 16 most actively traded currencies in another ‘whippy and illiquid’ trading range.

Forex heatmap

OK, it was a surprise, but not that surprising. Yesterday’s US existing home sales for Oct. managed to breach that psychological +6m mark (+6.1m vs. +5.54m) on fears that the first time home buyers incentives would be abolished. We now know that’s not to be the case, the program has been extended until the end of April next year. So, it’s probably a safe bet to believe that what we are witnessing can only be a temporary blip! How do we know this? In reality, pending home sales are 30-60 days advanced from showing up in re-sales. The +6m print was most likely pushed higher by the feared end-of-the stimulus and probably long enough to influence this months re-sales number. It will be important to look at the rate of cancellations of pending home contracts now that people have been given an extra 5-month to think about it. Digging deeper, the +10.1%, m/m, gain in sales was due to both single (+9.7%) and multi-family strength, while condos soared +13.2%. The stronger showing has led to a decline in months’ supply which fell to 7.0 from an upwardly revised prior month reading of 8.0. Single family months’ supply dropped to 6.8 while condos fell to 9.0. These are the lowest levels in nearly three years. Coming back to reality, it’s the post April environment that concerns analysts. ‘Incentives may be pulling forward future demand, only to postpone further weaknesses’. A disturbing trend persists with the prices sub-component. They continue to decline despite increased demand (median $173k and average $218k). Analysts believe that it’s the increase in the foreclosure rate that naturally increasing supply. As we already know that recent gains in demand are offsetting the increase, hence it’s a no-show in month’s supply.

The USD$ is currently higher against the EUR -0.33%, GBP -0.51%, CHF -0.36% and lower against the JPY +0.35%. The commodity currencies are weaker this morning, CAD -0.61% and AUD -0.82%. Yesterday’s Canadian retail sales numbers blew past all analysts’ expectation and even included positive revisions for previous months. The headline print (+1.0% vs. +0.6%) and core-details (+1.1% vs. +0.7%) confirmed that it was a strong report with nearly all sub-components reporting a gain in Sept. Real-sales were up +1.2% and it’s this element that will show up in real-GDP. The strong showing in Sept. will be a strong positive to monthly GDP and also hot on the heels of other decent data this month, excluding housing stats. The loonie managed to get a small lift on the data. However, the currency received strong support from the dismal ‘reserve currency’ performance vs. its largest trading partners and rabid commodity prices. By the beginning of yesterday’s session, the CAD managed to appreciate the most in 2-weeks in this rather illiquid shortened trading week down south. Last week we witnessed a paltry comeback of sorts for the USD, which was short lived, give way to newfound demand for risk trading strategies again despite lower short term yields. Technically, the market is lacking clear direction amongst the tight 3c trading range. Currently, within this tight range, intraday traders are been squeezed daily out of the core positions, whether it’s commodity prices pushing the loonie or risk aversion. Dealers continue to be better buyers of the CAD on USD rallies as the buck’s bear trend remains well established.

More global banking concerns have dampened the demand for higher yielding assets. Rumors that Germany’s WestLB may require capital injections and with its majority stakeholders prepared to let it become insolvent has strengthened the risk aversion trading strategy. The theory goes that more funds are required to strengthen the corporate balance sheet which may restrict economic recovery by limiting funds for smaller companies and households. This has put pressure on global bourses and by default the AUD. Over the last 12-months, the AUD has managed to appreciate just above 50% vs. the greenback as the RBA became the first Cbank to hike rates twice this year. Earlier this month, the RBA minutes implied that three straight lending rate increases may not be on the cards had futures traders unwinding some of their bets that Governor Stevens would tighten monetary policy again in two-weeks. He said that the pace of further rate increases ‘remained an open question’. However, bigger picture, the currency is well supported by commodity prices and expects dealers to remain better buyers on ‘deeper’ pullbacks (0.9177).

Crude is lower in the O/N session ($77.45 down -15c). Crude prices remain close to home, rising from last week’s one-week low on speculation that demand will increase as the global economy recovers from its worst recession in over 50-years. The commodity so far this week has been supported by heightened tensions between Iran and Western nations which raised speculation of a potential supply risk. Last Sunday’s war games in Iran have elevated tensions once again in the Middle East, thus providing us with ‘an insurance premium’. Last week’s EIA and API report confirmed the weakness of the weekly inventories situation. With US crude stocks falling by more-than-expected, and the dollar trading under pressure, had the market temporarily penetrating that psychological $80 a barrel level. Repeatedly over the last few weeks the $80 handle remains a stubborn resistance point, again the market attempted and again it has failed despite US crude inventories falling by -900k barrels last week vs. market expectations of a +300k increase. Confirming their support for bullish prices, both gas and distillate stocks also fell, by -1.7m and -300k barrels respectively. Again some technical analysts, justified by the markets reactions last week, we have come too far to fast. Demand destruction does not warrant elevated prices. OPEC will remain on hold next month because of concerns about tipping global economies back into contraction. To date the market has been wishy-washy within a $7 range with very little follow through. Do not be surprised if we cannot hold current levels as the greenback becomes in vogue again.

No surprises, gold jumped to another record yesterday as the greenback once again faltered against all its major trading partners. Thus far, the yellow metal has gained +32% percent this year as investors and central banks increased their holdings of the commodity to preserve wealth. Even the CBR (Central Bank of Russia) said it bought +19.5 metric tonnes last month, bringing their yearly total to +90 tonnes, and firmly establishing them as the world’s 8th largest holder of the commodity. They said that they want to hold 10% of their reserves in gold, that’s approximately 12-13 thousand tonnes or twice what they presently hold! Expect the bulls to continue to dominate all of the action and remain strong buyers on ‘any’ pull backs even if the USD finds support from risk aversion trading strategies ($1,167).

The Nikkei closed at 9,401 down -96. The DAX index in Europe was at 5,764 down -37; the FTSE (UK) currently is 5,325 down -30. The early call for the open of key US indices is lower. The US 10-year bonds backed up 2bp yesterday (3.39%) and eased 4bp in the O/N session (3.35%). All the worthwhile action continues to occur in the front-end of the US curve with 2-year note yields dropped temporarily to their lowest level in over a year on concerns that the rally in higher-yielding assets has outpaced the prospects for economic growth. Yesterday’s $44b 2-year auction was once again well received despite treasuries falling after stronger than expected US existing home sales. The bid-to-cover for the auction was a very strong 3.16 times. This is down from the 3.63 last month, but is nonetheless very strong, especially given that yields are now near their lowest levels of the past year. Even with rabid global equity prices and US T-Bills trading close to zero coupled with gold recording new record highs, one get’s the feeling that there is a huge flight to quality occurring, but presently has not hit the foreign exchange market. US refunding numbers for this shortened holiday week (5’s $42b and 7’s $32b) will make supply the main for reason for movement. Traders will continue to sell the curve as well as selling outright to make room for purchases. On deeper pull backs, the longer end of the US yield curve remains better bid as the ‘seasonal’s’ are calling for a flattening rally ahead of ‘month end index extension’.

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