Merkel No to Aid-EUR limbo

The political nightmare that’s being ‘toing and froing’ in mainland Europe is contributing to the risk premium of the EUR. Last week we witnessed the growth of a ‘divergence’ beginning to appear between the French and German governments over aid to Greece. Under his own domestic political pressure, Sarkozy favors EU based support measures, while Merkel’s Germany feels more constrained by the EU regulations which ‘preclude a direct bail-out of a member state’ and instead favors IMF involvement. The Greek’s on the other hand, remain the agitator. It talks of the potential need to call for IMF aid if no EU support is forthcoming. This week’s EU summit will likely set the future tone of the EU and their domestic currency. Expect the EUR to come under much further pressure if this summit does not result in Germany moving towards a direct internal support package. Perhaps we are witnessing the wheels coming off this Europe experiment.

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

Forex heatmap

A surprise interest-rate increase in India has fueled investors concerns that global recovery will stall as economic stimulus programs are wound back. This morning, global bourses and commodities have managed to paint a ‘sea of red’. Risk aversion-trading strategies are dominating positions taken on comments by the IMF that ‘advanced economies face acute challenges in tackling high public debt, and unwinding existing stimulus measures will not come close to bringing deficits back to prudent levels’. Now that the US Health Bill has been passed, and with no data today, markets will begin to anticipate what will be happening at this EU summit. ‘Buyer’s beware’ as rumor and innuendo will continue to drive theses markets.

The USD$ is higher against the EUR +0.19%, GBP -0.50%, CHF -0.07 % and JPY -0.15%. The commodity currencies are mixed this morning, CAD +0.03% and AUD -0.19%. With Canadian core-CPI rising to an unexpected +2.1%, y/y, and with another better than expected retail sales report (+0.7% vs. +0.5%), despite the fact that most of the increase was due to higher prices, should have Governor Carney and fellow policy makers feeling the heat. Fundamentally, after stellar reporting this month it’s difficult to continue to argue that ‘emergency’ rates in Canada are still warranted (+0.25%). Initially on Friday, the currency attempted to flirt with parity and registered its strongest print in 20-months. However, the over saturated and one directional trade ended the day weaker on profit taking. This reprieve or any reprieve will be seen as an opportunity to only add to longer term investors positions. The market now believes that there will be a forceful move on rates sooner rather than later. With the Fed ‘keeping’ low interest rates for an ‘extended’ period of time should support most growth currencies. Trader’s opinions have, up until now, varied on the timing of a hike. July Bax’s currently are pricing in a +98% chance of the BOC tightening, while some analysts are calling for a +50% hike. Despite the trend remaining your friend, the market should be looking for better levels to own the domestic currency.

Concerns that China will take additional steps to cool its economy have the potential to dampen demand for raw- material exports from Australia. This is exactly what is happening after the surprise Indian rate hike. The AUD has slid for a third-consecutive day as lower commodity and equity prices has pared demand for higher-yielding assets. With rumors that China is about to raise interest rates to prevent asset bubbles occurring has the AUD bulls trading cautiously. Prior to these rumors, it seemed the stars were lining up for a stronger AUD. Expectations for low interest rates in the US and Japan was fueling risk appetite. The market expects the RBA to hike with a ‘gradual approach’. Continue to expect better buying on deeper pull backs (0.9130).

Crude is lower in the O/N session ($80.34 down -34c). Despite crude remaining in bullish territory, traders were happy to lock in some profit after printing a 10-week high earlier last week as the dollar advanced. Technically the market remains optimistic, while fundamentally weak demand has us not so. In reality, US demand is better y/y, but we are still some ways from calling it as ‘tight’ demand. The bullish print this week was fuelled by the weaker than expected weekly inventory headlines. The report recorded a bigger than forecasted decline in supplies of gas and distillate fuels. Gas inventories fell -1.71m barrels to +227.3m last week vs. an expected decline of only -1.2m. Distillate supplies (which include heating oil and diesel) fared no better, decreasing -1.49m barrels to +148.1m. Stockpiles were forecasted to drop by -1.35m. On the flip side, inventories of crude rose +1.01m barrels to +344m. The market had anticipated an increase of +1.15m barrels, basically as expected. Other factors have also been raining on the ‘bears’ party. OPEC decided this week to keep its production limits unchanged ‘amid signs that a worldwide glut of crude is disappearing along with the recession’. Various analysts’ reports are now predicting that ‘demand for oil will recover this year, requiring additional supply’. The technical analysts are now eyeing $90 a barrel by year end. With investors believing that the economic situation will not get much worse should support commodities on most pull-backs. However, the Greek domino effect could provide some interesting support for the ‘bears’.

With a vengeance, the bears kicked back on Friday, paring gold’s strongest weekly gain in a month up to that point, as the greenback, a currency in demand, eroded the ‘yellow metal’s’ appeal as an alternative investment. Fundamentally it is expected that the commodity will find some traction as investors seek an alternative to an ‘on going weakening’ of the EUR and low interest rates. Last week, and after the Fed’s communiqué, we witnessed the commodity advance the most in a month on the ‘extended period of time’ comment. Analysts believe that with this ‘low rate environment combined with continued gold ETF interest and reduced Cbank sales’ should provide ‘strong’ support for gold over the next 18-months. Further interest to own the commodity may gain as the prospect of credit tightening in China persuades investors to seek a ‘haven in precious metals’. It seems that Europe investors will look to buy gold as an alternative to holding the EUR. However, the dollar’s direction remains the strongest indicator to wanting the metal or not ($1,107).

The Nikkei closed at 10,824 up +81. The DAX index in Europe was at 5,961 down -21; the FTSE (UK) currently is 5,620 down -29. The early call for the open of key US indices is lower. The US 10-year backed up 2bp on Friday (3.67%) and is little changed in the O/N session. Treasury prices stayed close to home despite stronger fundamental data. However, the 2’s/10’s spread again managed to tighten to its narrowest margin in 2-months (270bp). Bond traders have technically been unwinding ‘steepener’ positions and putting on flatteners as the Fed is ‘still willing to err on the side of keeping rates low’. The Fed reiterated that the recovery will be ‘slow and that rates will remain low for an extended period of time’. This week’s refunding requirements is expected to put further pressure on the curve as both traders and investors prepare to take down $118b worth of product (2’s $44b, 5’s $42b and 7’s $32b).

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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