Nakheel to Abu Dhabi ‘Please Sir, Can I have some more?’

Are Capital Markets under estimating growth in the US? Will current economic conditions allow the Fed to soon change its language? Will they begin at this two day meeting commencing today? Doubt it, Bernanke and his policy makers will continue to implement their low rate policy for an extended period of time. However, US data suggests that changing economic conditions will allow the Fed to soon change the ‘language’ and begin draining some of the $12t it has pumped into the economy. Yesterday, global stocks rose as default swaps prices fell after Abu Dhabi pledged to bailout Dubai’s Nakheel. But, what’s the cost? Are other bailouts in the region necessary? Despite consumer confidence up ticking in North America and Asia, most Europeans believe that the worst of the economic crisis has yet to feed throughout the labor markets (Euro-land unemployment sits at +9.8%)!

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

Forex heatmap

Its the season to be aware’, currencies are traded like ‘hot, rare commodities’ over the holiday period and worse still, by young inexperienced position keepers, who themselves create much of the extra noise surrounding a currency movement. The trick is to drown out the white noise and stick to the basic trading principles or secondly, pare positions, own some dollars for hedging purposes and enjoy that eggnog! Having to experience another yesterday twiddling ones thumbs will be excruciating!

The USD$ is currently higher against the EUR -0.58%, GBP -0.22%, CHF -0.63%, JPY +0.57%. The commodity currencies are slightly weaker this morning, CAD -0.24% and AUD -0.84%. Up until now the loonie had been trading within its tight holiday range, bothering no-one. (1.0450 to 1.0650). However, lack of liquidity and directional play is capable, even violently so, to create a new holiday trading range. This ‘new’ demand for the greenback across the board combined with sickly commodity prices is in danger of pushing the loonie to much lower levels, Last week, the loonie had been rapped on the knuckles and sits in the same boat as other growth and commodity currencies. The CAD is currently trading at the bottom of its recent tight range and is in danger of losing further support at the USD is threatening to end the year on a ‘high’! Last week the BOC shot a warning shot across the bow of the Canadian consumer. They said that recent rallies in equities and bonds may not be justified, and ‘that rising debt levels of Canadian households will make them more vulnerable when interest rates rise’. Carney said that ‘households need to asses their ability to service these debt obligations over their entire maturity’. Despite the BOC extending its commitment to keep borrowing cost low until well into next year, variable mortgage rate holders should be wary of a hike in long term yields despite the BOC’ remaining on hold. Expect liquidity to become a concern across the board as we close in on the holiday season. Again investors continue to be a comfortable buyer of the greenback on pull backs.

The RBA said it decision to raise borrowing costs to 3.75% for a record third consecutive month gives policy makers more flexibility in the future. It has in fact ‘the flexibility’ that has driven down the AUD as investor’s trimmed bets on a further increase in Feb. Stronger fundamentals justified the last hike. Year-to-date, the AUD has gained +32% vs. the USD, as investors continue to seek higher-yielding assets for the ‘carry’ trade. AUD managed to pare some of the sessions earlier losses after the Dubai Government indicated that Abu Dhabi was preparing to bank roll $10b of working Capital to help Dubai World meet its debt obligations. The AUD came under renewed pressure earlier in the session on speculation that the Fed may be moving closer to increasing borrowing costs after both Friday’s retail sales and consumer confidence headlines exceeded expectations. Despite growth currencies get a shot in the arm, capital markets remains focused on the US yield story. For now and until proven otherwise investors continue to be better buyers on dips (0.9076).

Crude is higher in the O/N session ($69.67 up +16c). Crude seems very much anchored to its two month lows amid speculation that demand will be slow to recover. Falling European industrial output combined with weaker than expected Japanese consumer confidence (the world’s third largest oil consumer) have aided the ‘demand destruction’ scenario. From the yearly high print achieved in late Oct ($82), oil has managed to pare 15% of its value. ‘Slow recovery’ in demand from the developed nations will for the foreseeable future impede prices rising. Technically we have entered a new trading range now that we have been able to breach that strong $70 support level. Last weeks’ EIA report showed that inventories climbed after refiners boosted their operations and imports fell. Oil stocks declined -3.82m barrels to +336.1m million vs. the market expectations of a gain of +600k barrels. On the flip side, gas stocks climbed more than forecasted and supplies of distillate fuel (heating oil and diesel) advanced for the first time in a month. Technically the report was a zero-sum game. Gas inventories rose +2.25m barrels to +216.3m vs. an expected increase of +1.6m, while distillate fuel increased +1.62m barrels to +167.3m. Refineries operated at 81.1% of capacity, up +1.4% points from last week and now at the highest level in 2-months. Two reason contribute to this, firstly, refiners are anticipating (optimistically) greater future demand and secondly, the need to reduce stock before the end of the year because of tax consideration. Overall it was a modestly bearish report. Fundamentals continue to promote demand destruction. Various OPEC members have been rather vocal of late ahead of their meeting at the end of this month. They believe that prices are in ‘the right range and there is no need to reduce inventories’. Expect the USD’s direction to dictate price action medium term. Cannot say it loud enough, but support levels continue to look vulnerable!

Gold was little changed yesterday. However, it is anticipated to rise as a weaker dollar will convince investors to buy ‘the yellow metal’ to hedge against further declines in the currency. In the course of the last week, the commodity has managed to fall just over $107 from this month’s highs to this month’s lows. Technically, the recent record rally required a healthy ‘lemming purge’ which seems to have stabilized around current levels. Even with all the noise and volatile movements in other asset classes these pull backs remain a strong buying opportunity for ‘the international currency’ ($1,116).

The Nikkei closed at 10,083 down -22. The DAX index in Europe was at 5,796 -5; the FTSE (UK) currently is 5,288 down -27. The early call for the open of key US indices is lower. The US 10-year bond backed up 1bp yesterday (3.55%) and are little changed in the O/N session. Treasury prices remain close to home ahead of the two day Fed meeting starting today. Again it is speculated that policy makers will remain consistent and keep rates on hold for ‘an extended period’ of time. Technically, traders have readjusted the shape of the curve after last weeks $74b’s worth of new issues. The mid-to-long end of the curve was not as well received. Over the past few trading sessions we have witnessed the 2’s-30 spread widen out to as far as 374bp (currently 365bp), the most in nearly three decades. A steeper yield curve reflects the ‘diminishing demand from investors anticipating faster economic growth and inflation’. Despite stronger US fundamentals, technically, longer maturities have entered oversold territory. If yields do not make an assault on 3.50% level again soon, then this illiquid market should expect to back up even further until the year end!

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