EUR entering ‘fly zone’?

Now that the market is so tightly wound short EUR’s we are beginning to hear more and more voices preaching to us that the currency is entering the ‘take-off zone’. It’s agreed that the EU has problems and the core being the central fiscal authority issue, but the ‘haves’ are adamant that the EUR is here too stay. They literally have too much invested, 60-years, for it to go under on its first attempt. Goldman Sachs’ O’Neill said it was ‘ridiculous’ to say that the EU would break up in the next year and he believes that we are close to the currency’s achievable lows. His reasoning is based on the misconception that the markets are trying to equate ‘economic logic with social political reality’. In the business we would say that he was talking his ‘book’ and is getting nervous about holding those long EUR positions! The record short positions are well documented, a squeeze is healthy and expected. Markets should be playing for a move.

The US$ is stronger in the O/N trading session. Currently it is higher against 11 of the 16 most actively traded currencies in another ‘whippy’ trading range.

Forex heatmap

Yesterday’s NY manufacturing (the first of the regional surveys) showed that it slowed this month after strong gains in Apr. (19.1 vs. 37.9). Initial reaction to the report does not bode well for the other surveys. Digging deeper, despite the pace of growth slowing, the report continues to show expansion in the manufacturing sector. Future expectations also weakened and it too managed to show expansion. The simple reason may be due to the current European debt situation and how it could negatively impact manufacturing activity state side. New orders, shipments, inventories and average workweek all saw a decline while employment continued to improve, evidence that Capital Markets should expect further gains in the manufacturing employment in next months NFP. The prices sub-component revealed that the prices paid continued to advance although prices received eased, again tightening companies profit margins. The six-month expectation category also declined with new-orders and shipments back to levels witnessed six-months ago. On the plus side, the average workweek returned to expansionary territory after turning negative last month. Let’s hope that this is the only deep eyesore of the regional reports.

Not all the US data reported negative yesterday. Global demand for long-term US assets rose to a new record in Mar. ($140.5b vs. $50.5b). Most analysts agree that the stronger fundamental in the US, proof of a ‘sustained economic recovery’ and the concerns about the sustainability of European government debt has investors backing the US Capital markets. It continues to be the safe heaven, risk aversion trading strategy.

The USD$ is lower against the EUR +0.02% and higher against GBP -0.00%, CHF -0.03% and JPY -0.22%. The commodity currencies are mixed this morning, CAD +0.49% and AUD -0.20%. Questions about growth and commodity prices greatly pressurized the loonie yesterday. Early in the session the currency managed to find some traction on news that the ECB purchased +16.5b EUR’s worth of bonds through May 14th. However, the concerns that the new European austerity measure that are being implemented will eventually cut the prices of raw materials that Canada has abundance of ended up hurting the loonie by day’s end. On a cross related basis the CAD continues to find strong buyers and has managed to print a 9-year high vs. the EUR as investors seek surety in a currency that has strong fundamentals. It’s worth noting that the aversion trading strategies that historically require purchasing of the USD in abundance and selling of the loonie are being ignored somewhat. The dollar has been in demand vs. most of its other major trading partners and not against its largest. Technical analysts have noted that the greenback wants to grind higher for surety reasons despite the threat of Canadian interest rate hikes. It seems that Canada’s strong fundamentals coupled with a ‘rapid’ gold market is bringing loonie buyers on dollar rallies back into the market. Loosening risk aversion and stronger crude prices will only promote the currency even more.

It’s not surprising with the doubt that the markets are experiencing with the EU/IMF accord that growth currencies have retreated from their initial euphoric high recorded earlier this month. Despite the AUD gaining some initial support earlier last week from a stronger job’s report (+33.7k vs. +22k), the currency has fallen for a third consecutive day against the JPY on concerns that the deficit-cutting measures by EU will eventually inhibit global economic growth, and by default reduce demand for higher-yielding assets. The AUD also weakened after the release of the RBA minutes. It revealed that policy makers considered borrowing costs were ‘well placed’ after six increases in seven meetings. Earlier this month Governor Stevens hiked rates (+4.75%) and commented that lending costs were back to ‘average’ (0.8719).

Crude is stronger in the O/N session ($71.60 up +160c). Oil managed to fall for a fifth consecutive day yesterday, dipping to its lowest level in three-months, as the robust dollar dampens investors’ demand for alternative investments and on speculation that Europe’s sovereign-debt crisis and rising weekly supplies signal that global demand will be slow to recover. In the O/N session we have witnessed somewhat of a rebound in sentiment and on market belief that tomorrows weekly report will show that refinery operating rates have increased. Last week’s inventory EIA report showed that stocks climbed for the 14th time in the last 4-months as refineries had various units lay idle. Supplies of crude increased +1.95m barrels to +362.5m vs. a forecasted climb of +1.6m. Inventories at Cushing increased +784k barrels to +37m (the highest level in 6-years). Not helping the cause, refineries operated at +88.4% of capacity, down -1.2%, w/w, the first decline in two months. On the flip side, gas inventories managed to fall, down -2.81m barrels to +222.1m. Analysts had expected an increase of +400k. This was certainly a bear report for the commodity. Of late, both the US economy and the dollars strength and not oil fundamentals have driven the market. The IEA has again cut its estimate of world oil demand this year by -220k to +86.4m barrels a day. According to the same organization, OPEC will need to pump +28.7m bpd to ‘balance global oil demand and supply this year’, that’s -400k barrels less than last month’s estimates. Over the last 5-trading sessions the ‘black gold’ has managed to shave -20% of its value. The market is relying on fundamentals and the oversupply of the commodity as conviction of this direction. Speculators continue to be better sellers on rallies.

Gold has managed to fall to a one week low in the O/N session as equities rebound thus curbing the safe heaven demand for now. For the past 10-trading sessions it has constantly recorded new record highs (USD, EUR, GBP, JPY and CHF) on concerns that the EU/IMF loan accord to bail out indebted nations in Europe may not be enough to contain the sovereign debt crisis. Investors have been speculating that the EU/IMF accord could ‘cement easier monetary policy’ and promote inflation. Europeans it seems want to be in the ‘currency of last resort’ and are using the commodity as their second reservable asset, supplementing their EUR denominated assets. Others have outright been liquidating their EUR holdings and buying gold ahead of a possible ‘dissolution of the monetary union’. The technical bulls believe that $1,400 is a possible one-year target. For now, the market is a better buyer on deeper pull backs ($1,214).

The Nikkei closed at 10,242 down -7. The DAX index in Europe was at 6,122 up +56; the FTSE (UK) currently is 5,281 up +20. The early call for the open of key US indices is higher. The US 10-year remained relatively close to home yesterday (3.46%) and is little changed in the O/N session. The treasury bears seem to be back peddling and revising year-end yield targets. The excuse, the Europe’s sovereign debt crisis ‘did not appropriately discount the sovereign risk conditions’. It’s no wonder that the $78b issued last week went so well. Treasuries prices continue to find support despite the stronger US data. The demand for the ‘safest assets’ rose on speculation that Europe’s sovereign-debt crisis will limit growth and lead to the eventual breakup of the EUR. Yesterday’s TICS data confirms the market sentiment. The 2/10’s spread at 266bp shows that the flight to quality remains very much intact, for now at least.

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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