PIIGS hurt EUR

Are we missing the big picture? How come markets seem to be trading as if the global risks to economic recovery have been dealt with? Our savior, China is even taking steps to slow things down by hiking Bill rates and increasing reserve requirements. Europe is a mess. A dovish Trichet yesterday said that Greece would not receive any special treatment. German Chancellor Merkel said Greece’s deficit ‘may hurt the EUR’. In reality, the ‘PIIGS’ (Portugal, Ireland, Italy Greece and Spain) fiasco collectively is getting worse. It’s a situation not contained, not unlike the sub-prime debacle. In the US, many states face ‘a severe financial crisis’. Back in reality, we could see Asian stocks plummet, ECB lose total control and US State budgets suffocate any kind of recovery. Have the ostrich syndrome trading strategies taken this into account?

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

Despite the ‘negative’ headline read with US initial jobless claims coming in higher than expected (+444k vs. +433k), we should take heart that they remain close to that +400k print. Economists, analysts and traders will tell investors that the job recovery is underway in the US. A positive trend revisions in last weeks NFP combined with continuing claims falling 4% (4.59m vs. 4.75m-largest drop in 3-months) is a strong suggestion that the ‘elimination of jobs is decelerating’. Digging deeper, the report provides more positives, the number of unemployed workers claiming benefits under the EUC (emergency unemployment Compensation) fell for the first time in 2-months (+5.0m vs. +5.1m). Unfortunately the other benefit program, extended benefits, advanced slightly last week (+302k vs. +296k). Collectively, these programs, initial, continuing, extended benefits and emergency compensation show that jobless claims as a whole fell w/w. Analysts expect improvements in both the initial and continuing claims this quarter as companies reverse the ‘firing’ actions and actually begin to hire once again. A note of caution however, the duration of unemployment continues to move higher due to companies’ reluctance to speed up the hiring process, we should expect weakness in the various emergency benefits programs.

It seems that Capital Markets have pushed out further the timing of any rate hike from the Fed after yesterdays disappointing retail sales data. The negatives, sales unexpectedly fell in Dec. (-0.3% vs. +0.4%) and the positives, revisions were higher than previously estimated. Net result, market interprets that the economic recovery will ‘be uneven’, hindered by a high unemployment rate, tight credit and falling home values.

The USD$ is currently higher against the EUR -0.62%, GBP -0.03%, CHF -0.61% and lower against JPY +0.38%. The commodity currencies are weaker this morning, CAD -0.31% and AUD -0.51%. Historically, when the ‘US dollar caught a cold, the loonie suffered from pneumonia’. It was because of its proximity and strong economic ties with its southern brethren. That correlation has long ceased, stronger Canadian fundamentals and the world’s appetite for the country’s rich commodity sources has the loonie encroaching on parity in the near future. Over 50% of total export revenue is from raw materials. The general malaise of the ‘big dollar’ of course adds fuel to the fire. The BOC has its rate announcement next week. The market will expect rates to remain on hold (+0.25%). Governor Carney and fellow policy aids have been vocal and adamant that rates will ‘stay low’ until after June or until inflation becomes an issue. At the same time they have expressed the concerns on the strength of their currency and what it could do to future economic growth. The Governor has a tough call as they cannot manipulate rates. That will only worsen the situation. We should expect them again to try and talk down some of its strength. Technically, the currency has come too far too fast. There are decent ‘size’ speculators willing to sell the loonie on dollar weakness. However, all things being equal, any glimmer of growth will have the loonie trading above parity sooner than we think.

After the initial euphoria of the stellar Australian jobs report, the currency has come back to earth. The AUD has fallen from its 2-month high print on concerns over the sustainability of the ‘global economic recovery dampening demand for higher yielding assets’. Despite jobs gaining for a fourth consecutive month and the jobless rate falling to 5.5%, comments from the World Bank chief economist on their concerns that a relapse into a recession is a possibility has pushed the currency towards its first line of support (0.9250). Strong fundamentals and robust commodities have kept the RBA on their toes regarding tightening monetary policy. The economy is now well into a recovery phase and adds pressure on Governor Stevens to increase the O/N borrowing cost to 4% for a fourth straight meeting next month.

Crude is lower in the O/N session ($78.93 down -46c). Yesterday, crude fell for a fourth consecutive day as US retail sales disappointed and the headline jobless claim print rose. Couple this with a bearish weekly EIA report supported by the earlier API findings has legitimate sellers queuing to sell on any rallies. The reports revealed rising US distillate inventories, despite the severe northern hemisphere winter. Crude inventories rose +3.7m barrels to +331m barrels last week vs. an anticipated climb of +1.5m. Gas fared no better, its supplies advanced +3.79m barrels, or +1.7%, to +223.5m. Analysts again underestimated the levels, as they expected only a rise of + 1.7 million barrels. Finally, distillate fuel inventories increased by +1.35m barrels to +160.4m, compared with an estimated drop of -1.3m barrels. Fundamentally, the combined distillate number remains a strong sell indicator. The commodity has fallen just under -5% since China announced increasing its Bank reserve requirements and this after a +15% gain over the illiquid holiday trading season. Global fundamentals reinforce the ‘demand destruction theory’. Stalling UK and German economies combined with China hiking its bill rates, has investors nervous about riskier trading positions.

Already this week the ‘yellow metal’ has managed to print a new monthly high ($1,163) as a weaker greenback increased demand for the commodity as an alternative investment. Traders had been taking it upon themselves to book some profits after the +5% rally. Since the lows the commodity has rebounded as investors demand for a haven from a weaker dollar and lower prices for other commodities boosted the ‘yellow metal’ prices. On deeper pull back investor’s remain strong buyers ($1,135).

The Nikkei closed at 10,982 up +74. The DAX index in Europe was at 6,013 up +25; the FTSE (UK) currently is 5,516 up +18. The early call for the open of key US indices is lower. The US 10-year eased 7bp yesterday (3.71%) and is little changed in the O/N session. Weaker US sales and jobless data coupled with Trichet’s comments about the ‘unclear’ future of economic growth in Europe managed to attract buyers along the US yield curve. Fundamentally, data is stating that any sign of recovery will be ‘modest’. Hence, investors desire to grab yield and insurance of in the FI asset class. Yesterday’s long bond auction was well received. It came in at a yield of 4.64%. The bid-to-cover ratio 2.68 compared with 2.45 in Dec and 2.26 in Nov. The past four auctions average was 2.5. Indirect bids registered at 41% vs. 40.2% in Dec., while direct bids were 5% compared to 6.9% in Dec and 12.1% in Nov.

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