EUR correction a trend reversal for irrational traders

It’s the US dollar libor, the pain of Spanish Banks, Korea, and China’s pending bubble, a trillion dollar bet going sour, restrictions on naked short selling and that’s this week’s issues that are driving investors to seek shelter. The volatility in the currency market begs the question, are risk adverse investors too bearish? Watching how various asset classes ‘snap back’ into positive territory with aggression this morning is telling. Investors are trading ‘intraday’ more now than ever. It’s true that volatility brings great opportunities. However, mounting losses in other asset classes is also driving this volatility. It seems that investors are indecisive in their trading thoughts, the bottom line is so much more important as they juggle with catching a correction or remaining true to the trend. What if the correction is a trend reversal? No matter what, market participants’ acting ‘irrational’ is a lagging indicator and we should expect more of the same for the time being.

The US$ is stronger in the O/N trading session. Currently it is higher against 13 of the 16 most actively traded currencies in another ‘whippy’ trading range.

Forex heatmap

Yesterday, US data ended up providing a footnote to other global concerns as economic and political headlines dominated all asset class movements. Surprisingly, US consumer confidence increased this month (63.3 vs. 57.7), managing to record its strongest print in two-years as consumers became more upbeat about future job prospects. It all comes down to spending. With US growth indicators indicating expansion in the economy, starting in the middle of last year, is finally beginning to negate the ‘pessimism’ that has been dominant throughout this recession. Basically the underlying economy is improving the job opportunities. Proof is in last months NFP print. Is this sustainable? Last week’s weekly claims numbers again edged higher and is beginning to raise a red flag. In the bigger picture, confidence is very much at risk of stalling as Europe’s debt crisis continues to weigh on global equities and eventually erode household wealth. Digging deeper into the report, consumers were more optimistic about the labor market with the number that felt jobs were not as hard to get declining from 44.8% to 43.6%. Those saying that jobs were plentiful, however, also ticked down slightly. Their assessment of business conditions also improved, with the numbers saying that conditions are ‘good’ increased to 10% while the number saying that conditions are ‘bad’ declined to 39.3%. The six month future expectation has consumers expecting more jobs, improving business conditions and higher incomes.

The S&P Case-Shiller seasonally adjusted measure of house prices fell less than expected in Mar. (+2.3% vs. +2.6%). It is the second consecutive monthly dip after a string of eight consecutive gains. However, year-over-year prices are up +2.1% in the first quarter.

Finally, the manufacturing activity in the Richmond Fed’s district remains in expansion mode (26 vs. 26), but the pace is decelerating. Digging deeper, one notices that the rate of growth in shipments accelerated, but the strong pace of growth in new order volumes eased up somewhat from the elevated levels the previous month. Analysts believe that the order backlog coupled with stronger new order volumes should provide ‘shipments strength in coming months’.

The USD$ is higher against the EUR -0.31%, GBP -0.10%, CHF -0.18% and JPY -0.05%. The commodity currencies are mixed this morning, CAD -0.14% and AUD +0.38%. The loonie managed to print a six-month low yesterday as investors shied away from growth assets. With equities and commodities plummeting on fear of further weakness appearing in the Spanish banking system and tension between the Koreas is tentatively promoting risk aversion trading strategies. This month alone the CAD has lost just under -5.5% vs. its southern neighbor as investors seek refuge from the European sovereign-debt crisis. The flight to quality, equity losses and the fear of a multilateral currency intervention has had the CAD underperforming also on the crosses. OIS’s are currently prices a 50% chance that the BOC will hike in June, earlier last week the market had priced in a 75% chance. If this uncertain environment continues then the market will want to unwind some of the interest premium already priced into the currency. Longer term investors are looking at the 1.1000 level to begin again buying the loonie.

The AUD fell for a third consecutive day as investors sold higher yielding assets on concerns that the European debt crisis will worsen and on reports of escalating tensions between North and South Korea. Currently the currency is heading for its worst performing month in nearly two-years as investors shy away from growth currencies. Plummeting equity markets in the region and potential War rhetoric apparently from Kim Jong has pushed the currency lower against nearly all its major trading partners. So far this month the AUD has managed to slide -12% on declining equity and commodity prices. It’s not surprising with the doubt that the markets are experiencing in the EU/IMF accord that growth currencies have retreated from their initial euphoric highs recorded earlier this month. Thus far, the AUD longer term support levels after the weekend sell off remain intact, the market prefers to be a better seller on rallies (0.8297).

Crude is higher in the O/N session ($70.44 up +166c). The fear that the European debt crisis will persist, and affecting global growth, had crude prices again under pressure yesterday. The commodity managed to register a 5-month low as the EUR slid vs. the USD, thus reducing the investment appeal of the asset class. In the O/N session prices have rebounded aggressively on the back of an API report showing that US gas stocks falling and on global bourses paring most of this week’s earlier loss. This morning we get the weekly inventory report. Prices seem to be trying in vain to rebound on oversold indicators. Last week’s EIA report managed to record a ‘smaller positive print’, showing that crude stocks gained +200k barrels vs. a market expectation of +1m. On the other hand, gas stockpiles fell -300k barrels. Interestingly, again inventories at Cushing (the delivery point for benchmark WTI) rose +917k barrels to a new record of nearly +38m. Not helping the crude’s price is refinery runs dropping to 87.9% of capacity, from 88.4%. With global equities under pressure is only fueling concerns that the region’s debt crisis will worsen, and by default it may affect global demand. The US economy and the dollars strength and not oil fundamentals have driven the market to date.

Last week the story line was the EUR appreciating, equity losses mounting and inflationary fears ‘none’ existent had speculators heading for the exits. Now that the EUR has lost some of that firm footing, equity losses continuing, has again revived the demand for the commodity as a ‘safer heaven’ asset class. Over the last five trading sessions, the yellow metal managed to depreciate -4.2% as investors liquidated positions to supplement losses in other asset classes. Longer term investors have been using the commodity as a ‘currency of last resort’ in addition to their EUR denominated assets. 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 ($1,209). Soon we will have to be using an excuse of inflation if the equity market can remain firm!

The Nikkei closed at 9,522 up +63. The DAX index in Europe was at 5,766 up +96; the FTSE (UK) currently is 5,037 up +97. The early call for the open of key US indices is higher. The US 10-year backed up 4bp yesterday (3.16%) and another 7bp in the O/N session (3.23%). Treasury yields managed to print yearly lows on the back of plummeting global bourses and on fear that Europe’s fiscal crisis will slow economic growth. Even in these trying times dealers have cheapened up the curve to absorb Government supply. Yesterday, Treasury’s two year auction came in at a yield of +0.769%, the lowest auctioned yield for a two-year note sale. The bid-to-cover ratio was 2.93, compared with 3.12 from the past four auctions. On a macro level, treasury prices should remain bid as demand for the ‘safest assets’ intensifies. Today we have $40b 5’s and $31b 7-year notes tomorrow to contend with. Technical analysts are looking for a 3% print in 10-years.

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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