Euro’s deflation outshines China’s covert retaliation

The round-table internal bickering officially begins amongst EU members today. Will they fail to agree on decisive measures to help Greece tackle its fiscal deficits? The EUR’s trading pattern tells us that the members are having an up hill battle to contain the deficit concerns that plague the PIIGS. Fitch’s ‘death nail’ downgrade of Portugal’s credit is only adding fuel to the flames. This week, currency markets have a couple of other side shows that should make it rather interesting over the next few trading sessions. What will the SNB do? Will intervening actions provide a strong knee jerk reaction from the EUR? More importantly, is the US on the precipice of a failed treasury auction? I wonder if China was involved in the low indirect bids at yesterday’s 5-year auction that caused a 4bp tail. Perhaps it’s a ‘pegged’ Yuan retaliation technique.

The US$ is weaker in the O/N trading session. Currently it is lower against 11 of the 16 most actively traded currencies in a ‘subdued’ trading range.

Forex heatmap

Yesterday’s US durable good orders advanced for a third consecutive month, albeit, somewhat a mixed report. The market does expect further gains as the economic outlook becomes more optimistic. Digging deeper, the increased demand in aircraft orders, machinery and metals was offset by weakness in electronics. Despite this, both the headline (+0.5%) and the core (+0.9%) continues to strengthen. This should imply upward pressure in ‘production in the coming months as the just-in-time management cycle continues to outperform’. The market is always happy to see business investment rebounding, stronger evidence for an optimistic outlook. It was a pleasant surprise to see inventories strengthen (+0.3%). It should provide a positive first time inventory print this quarter. It’s been a long time in coming. On the flip side, a decline in the volatile defense orders happened to keep the headline print below that psychological +1% watermark. Ex-orders and we would have experienced a +1.6% advance. Finally, shipments fell a further -0.6%, m/m and not surprisingly, it was transportation again the culprit for all of the deterioration. Ex-transportation and shipments would have risen +0.4%.

Slightly depressing, but not surprising, was yesterday’s US New Home sales dropping to it lowest level on record (-2.2% or +308k units vs. +315k, m/m). The usual suspects continue to depress the market, winter blizzards, unemployment and the rate of foreclosures. It’s the clash of New Homes vs. the foreclosure-induced declines in prices for existing homes. This ongoing battle will continue until the ‘cheap’ excess supply is finally absorbed, and to think that shadow inventories have not entered the equation. The supply of homes at the current sales rate increased to +9.2 months’ worth, the highest print in 11-months. On a positive note, the median price of a new home’s increased +5.2%, y/y.

A disturbing tidbit is that the US bank lending contraction is accelerating. Year-to date, lending by all commercial banks has fallen by -8.2%. Analyst’s note, that it is the largest decline in nearly 30-years, and is providing stronger evidence why the Fed is likely to keep interest rates close to zero for much longer than the markets expect. One wonders, if this headline print continues to deteriorate, will the Fed be forced to revive the asset-purchasing scheme that’s on its way to pasture?

The USD$ is lower against the EUR +0.00%, GBP +0.22%, CHF +0.18 % and JPY +0.29%. The commodity currencies are stronger this morning, CAD +0.28% and AUD +0.33%. Despite the loonie conceding its largest loss in over a month vs. its southern partner yesterday, the currency continues to outperform many of the G7 currencies. The CAD lost headwind after Portugal was downgraded convincing some investors to seek some surety and exit their ‘growth’ positions. Even Governor Carney tried to get in on the act yesterday by reiterating that rates will remain on hold through June. The loonie is hanging in tough, this time last week the currency was piggy-backing parity. The CAD continues to remain a good news story with stronger fundamentals continually trying to push the loonie higher. Its equities and commodities that have temporarily stalled the one directional over saturated play. A healthy purge of weak long CAD positions has the loonie bulls adding to their positions. To date the USD rallies have been shallow and continued to be met with strong resistance. We will however experience ‘one wild and crazy’ trading sessions where technicals and fundamentals do not make sense. Despite the trend remaining your friend, the market should be looking for better levels to own the domestic currency.

The AUD found some momentum in the O/N session after experiencing its biggest drop in two-months the previous day. Again, RBA rhetoric provided the support, reiterating that the benchmark borrowing costs need to climb toward ‘normal levels’ to contain inflation. The policy member’s comments reinforce the fact that the Australian ‘is in a strong position economically and there continues to be inflationary price movements’. The current AUD direction, like all growth currencies, depends on European factors. If we see no consensus on Greece then risk aversion will continue to play out and market will push commodity currencies lower. To date, weaker commodities and equity prices have pared demand for higher-yielding assets. 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 (0.9123).

Crude is higher in the O/N session ($80.78 up +17c). Crude prices have no legs. Oil remains under pressure after this week’s EIA report reveled a bigger than forecasted increase in inventories while the ‘buck’ ballooned to a 10-month high vs. the EUR. As we all know a strong dollar curbs investor’s enthusiasm to own commodities. Yesterday, crude stocks increased four-fold, rising +7.25m barrels to +351.3m barrels, w/w. The market was only expecting an increase of +1.65m barrels. Compounding the net effect, imports of the ‘black-stuff’ gained +12% to +9.4m barrels last week, the highest print in 6-months. On the flip side, gas stocks fell -2.72m barrels to +224.6m vs. an estimated drop of only -1.5m barrels. Not to be outdone, distillate fuel (heating oil and diesel) declined -2.42m barrels to +145.7m. A decrease of -985k barrels was forecasted. The four-week US demand average was +19.36m barrels a day, up +3.6% y/y, while gas consumption averaged +8.95m barrels, up +1.2%. Finally, refineries are operating at +81.1% of capacity, up +0.6% w/w. On the face of it, there is plenty of spare capacity available for when demand picks up. There is heightening concerns for sustainable global growth, especially with Europe remaining under the microscope. Technically the market remains optimistic, while fundamentally weak demand has us not so. A strong greenback is commodities biggest opponent, as the dollar’s rise is providing a commodity price ‘headwind’.

As expected yesterday, the dollar continues to cause havoc with gold technical’s and fundamentals. The surging buck, or weaker EUR, is curbing demand for the ‘yellow metal’ as an alternative investment vehicle. All week the commodity has found it difficult to find or maintain any traction and has been curtailed to a tight volatile trading range. Other headline stories like India hiking rates (the world’s largest consumer of gold) has investors seeking assurance in short-term paper as an alternative return. A disturbing trend from India, as a consumer last year their domestic demand fell -19%. Fundamentally it’s 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. However, the market is seeing little evidence of that demand, perhaps further weakness needs to be witnessed before that scenario plays out. What about the IMF? Will they require selling gold to finance a Greek bailout? The commodities highs are getting lower and suggest that further weakness is warranted in the short term. Year-to-date, support remains at $1,075-80, but looks vulnerable. The dollar’s direction remains the strongest indicator to wanting the metal or not ($1,088).

The Nikkei closed at 10,828 up +14. The DAX index in Europe was at 6,048 up +9; the FTSE (UK) currently is 5,683 up +6. The early call for the open of key US indices is higher. The US 10-year backed up 14bp yesterday (3.82%) and is little changed in the O/N session. Supply and the fear for sovereign debt have pushed momentum towards higher yields along the curve. Yesterday’s 5-year auction was poorly received. There was a 4bp ‘tail’ (2.605%), the worst in nearly a year and indirect bids (39.7%) were the lowest since last July. This bodes poorly for today’s final $32b 7-year auction. We can expect investors to seek further concessions. Yesterday’s issues were all about ‘uncertainty and liquidity, rather than levels’.

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