Lax Stress-Tests to hurt EUR

There is so much ‘noise’ in the market at the moment. It’s leading to tepid position taking as investors are unsure what to do. Risk-on and off again is playing havoc with the EUR/JPY sentiment index. This week, the market has focused on the ‘austerity measure’ theme. Weaker North American data has lent support to the idea that austerity measures will certainly slow the Euro-zone economies, and at the same time lend support to the ‘soundness of the currency’. Will the release of the criteria by the CEBS for the EU banking sector stress tests have an impact today? The committee will announce the banks that will be subject to the stress tests as well as the scenarios. Lax-testing criteria will hurt the EUR as the market will lose faith in the Euro-banking system that relies so heavily on ECB funding.

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 ‘volatile’ trading range.

Yesterday’s ISM non-manufacturing headline and details disappointed (53.8 vs. 55.4), signaling a ‘measured slowdown in the pace of expansion in the services sector’. However, above a 50 print still signals growth in the US economy. What is discouraging is that the pace of
increase in new-orders slowed more than anticipated. Despite remaining in growth territory (54.4), the pace has dramatically slowed from this year’s peak (62.3). Nevertheless, analyst’s note that the ‘backlog of orders remain largely unchanged, which signal enough pipeline momentum to add to industrial output gains in the months ahead’. Digger deeper, new-export orders slipped into contraction mode. The sub-index is not seasonally adjusted and may even signal ‘the impact of softening global growth and a stronger dollar’. Combining the two reports, ISM’s manufacturing and services, the reading continues to signal growth, albeit, at a slower pace (54.1 vs. 56 in April). Other sub-categories showed that Business activity continued to recover for the seventh consecutive month. While disappointing and a concern for next month’s NFP print was the Employment activity contracting in the services sector to 49.7 after just one month of growth. The Inventory levels expanded for the third consecutive, while the Prices paid component also edged higher, but at a tepid pace, supporting the Fed’s ‘extended period of lower interest rates’.

The USD$ is higher against the EUR -0.28%, GBP -0.31%, CHF -0.23% and lower against JPY +0.37%. The commodity currencies are weaker this morning, CAD -0.19% and AUD -0.37%. Canadian building permits tanked yesterday (-10.8% vs. -1.3%). It was a ‘bleak report’ that displayed widespread losses in value and volume terms within both the non-residential and residential categories. This however only caused a minor irritation to a currency that yesterday found favor amongst investors after being subjected to three days of constant battering. But, today is a different story, again global markets are apprehensive about growth and again this is having a direct impact on higher yielding growth currencies. The loonie has been the worst performing currency vs. its southern neighbor from a basket of most traded currencies over the past month. Dealers are somewhat backing down and even questioning whether the BOC remains in a ‘normalizing’ rate mood after last months expected rate hike. Over the past few week’s the global economic landscape and attitude has definitely changed, pointing to a tough 3rd Q, and even a negative 4th Q. On the crosses, CAD is trying to hold its own and under normal conditions is seen as a safer way to play a global economic recovery with links to commodities and less banking. Speculators had been betting that Cbanks will up the ante and use the currency as a safe haven destination for capital. In the current environment, USD sellers may have misplaced their desired entry points and are now forced to be better buyers of the loonie on up-ticks 1.0750-800.

The AUD has fallen from its one-week high on signs that global economic recovery is dampening demand for higher-yielding assets. In the O/N session, the currency has managed to slip against 15 of the 16 most traded currencies as Asian bourses fell after yesterdays US data. Technically, the Aussi losses should be somewhat limited ahead of their own employment report this evening. The currency has already received a shot in the arm this week as Governor Stevens left the cash O/N rate unchanged for a second consecutive month (4.50%). In his following communiqué, the RBA stated that consumer spending and business investment are expanding. This dragged the currency to outperform all its major trading partners. Policy makers are ‘reinstating their view that domestic growth will be about trend’ and are ‘not alarmed by the global demand backdrop’. In retrospect, policy makers remain ‘very upbeat’. This is certainly disappointing the ‘doves positioning’. The market continues to speculate that the Fed will keep interest rates at a record low to aid a ‘waning US recovery’, is preserving the regions yield advantage. With the crisis in Europe not having a material impact on the Australian economy has ‘bulls’ better buyers on pull backs. Be wary of commodity prices, market euphoria can only love the currency so long (0.8464).

Crude is lower in the O/N session ($71.65 -33c). With Crude rallying yesterday managed to stop a week’s rot of consecutive losses on the back of global equities rising and the dollar weakening. This increased the appeal of commodities as an inflation hedge. It seems that investors were buying on speculation, assuming that the recent stock losses were a tad excessive. This theory and scenario did not last too long as again the commodity comes under pressure. The recent weakness was in part due to the global concerns over slower growth and demand for fuel as China and the US economies showed signs of fatigue. Last week, weaker manufacturing and employment reports kept the ‘black-stuff’s’ prices at the lower end of a tightly defined trading range. Currently, crude is fighting for every dollar uptick as the bear’s continue to have a stranglehold on prices. Last week’s EIA report showed that gas inventories rallied for the first time in 2-months while crude stocks fell. Gas stocks rose +537k barrels to +218m vs. an expectation of a decline of -400k barrels. On the flipside, crude stockpiles fell -2.01m barrels to +363m vs. an expectation loss of -1m barrels. Supplies of distillate fuel (heating oil and diesel) also managed to climb to a two month high print. Distillate fuel climbed +2.46m barrels to +159.4m. The market had been expecting a +950k barrel gain. It was a market bearish report as the build in gas and distillates are offsetting the larger than expected drop in crude. Oil was down -9.8% for the quarter and -4.8% this year. Crude stocks remain well above the five-year average level, and are +3.2% above a year ago, the biggest year-on-year surplus in 6-months. Currently there are too many negative variables that support the bear’s short positions. Direction is dictated by demand and investor confidence, with ample supply and global growth worries, speculators continue to sell on rallies.

Gold fell -3.4% last week. Yesterday, the first trading day back after US Independence Day celebrations, the commodity pared another -1.1%, as the extreme risk-aversion linked to fears over sovereign debt issues in European countries abated. A rebound by the EUR has reduced demand for the metal as a haven. Technically, the bullish sentiment is on hiatus with profit taking testing the medium term support levels. Last month, gold rose to records in CHF, GBP and EUR’s amid Europe’s fiscal crisis. Fundamentally, in the short term the metal will find it difficult to rally aggressively, as historically, this is the ‘slowest’ season for physical demand. It’s been calculated that India, the world’s biggest consumer, imports may plunge as much as -36% this year. Despite this, on the longer term view, market concerns over global economic growth should support the ‘yellow’ metal and push prices to new record highs in the 4th Q. The upward bias trend remains intact as long as $1,175-80 holds. Year-to-date, the commodity has gained +10%. Thus far, Europeans have been content in using the commodity as a hedge against their European holdings, believing that the EUR has not bottomed out just yet ($1,188 -$11)!

The Nikkei closed at 9,279 down -59. The DAX index in Europe was at 5,867 down -73; the FTSE (UK) currently is 4,902 down -62. The early call for the open of key US indices is lower. The US 10-year eased 3bp yesterday (2.94%) and another 3bp in the O/N session (2.91%). The initial reaction to ISM had yields not straying too far after a weaker non-manufacturing headline print. Treasury prices for the safer-haven product for a period were ‘softer’ as a risk rally in global equities discouraged heavy investment. However, the lack of follow through with stocks and with the US economic outlook not looking so hot has the market providing support on pull backs. Investors are still trying to decide if they are witnessing a tepid US recovery from the worst downturn in 70-years or perhaps something not so optimistic. No matter what, yields will remain low for ‘an extended period of time’.

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