The squeeze commences as EUR doubts begin

Are they wrong? They keep selling to average, but, the squeeze is on as the EUR inches higher. They are questioning the strength of their bearish convictions believing that the EUR should be lower. What is happening to the safe heaven status of the USD? It’s playing mind games with all the bears’ theories. Yen and sterling are just as confusing! Concern that the US economic recovery is faltering and could prompt further monetary easing by the Fed has been growing ever since this weeks Fed minutes. Even this earnings’ season has not been able to temper this week’s reactions. The markets have not found their conviction just yet, price action continues to trade cautiously by prodding in either direction. Being a long economic week, the market will be happy to get inflation and confidence numbers out of the way this morning.

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

The US released a plethora of data yesterday, resulting in a new two-month EUR high as weak short positions and option barriers dictated most of the initial flow. The Philly Fed factory survey was softer than expected for July, the weakest reading in 8-months (ISM-weighted down 3.3pts to 50). The report produced only one bright spot and that was in the employment index. It moved from a negative to a positive reading last month. Other notable categories, like the forward looking indicator and current orders were notably softer. A bit of an eye opener was the business activity index, falling 15 points to a 16-month low of 25. Not dissimilar, was the Empire State Factory survey, softening further last month (ISM-weighted fell 3.5pts to a 5-month low of 52.3). Expectations were mixed, with general activity outlook remaining close to 41, while the forward looking indicator was less ‘upbeat’. It was not surprising to see that the employment and the capital spending indexes both fell as overall growth expectations remain questionable amongst all survey respondents.

A tad or a surprise yesterday was the US industrial production rising (+0.1%). The market had been expecting a decline of a similar amount. Last month’s upside surprise was offset by a small downward revision to the previous month. This resulted in the capacity utilization rate coming in as expected at 74.1%. Digging deeper, factory output fell by -0.4%, while mining and utility output came in marginally stronger. Analysts do not believe that the reading will have much of an influence on the outlook. They note that July’s early indicators show that the ‘higher’ production patterns in autos should contribute to a strong increase in this months output.

It was weekly unemployment claims that truly surprised the market with its headline. Despite initial claims coming in much stronger than expected (+429k vs. +448k) it is the ‘least reliable of all the reports yesterday’. The decline is partly due to a seasonal adjustment problem in the factory sector and one should expect it to be partially reversed next week. Digging deeper, continuing claims reversed last week’s decline (-203k to 4.434m), it bounced back to +4.681m. It’s worth noting that the continuing claims portion’s average is moving sideways. The extended and emergency claims fell by a total of +255k to a combined level of +4.32m in unadjusted terms.

And finally, the Producer Price Index (-0.5% vs. -0.2%) managed to surprise, but nothing of undue significance. The unexpected steeper decline was mostly due to food prices falling -2.2%, outstripping the decline in energy prices (-0.5%).The core finished goods index decelerated to a +0.1% after two consecutive months of +0.2% gains. Overall, it’s proof that pipeline pressures are subsiding. The monthly finished goods numbers pulled the y/y rise down from +5.3% to +2.8% and the y/y rise in the core measure from +1.3% to +1.1%. Will analysts begin changing their CPI calls? They probably will not.

The USD$ is lower against the EUR +0.07%, GBP +0.01%, CHF +0.10% and JPY +0.23%. The commodity currencies are weaker this morning, CAD -0.14% and AUD -0.57%. There is an 85% strong correlation between the Dow’s movements and the loonie. Everyone and their mother want to own the currency and yesterday’s price action was able to squeeze out the weak longs as equities saw red. Stellar fundamental reports of late have traders increasing bets that the BOC will hike rates for the remainder of the year. It seems to be a done deal that Governor Carney will raise +25bps next Tuesday and perhaps another +25bps in Sept. At +1%, Carney has the latitude to step back and assess global growth for the 3rd Q, which in fact could persuade policymakers to ‘skip a beat’ and pause, so that they do not get too far ahead of their southern neighbor. Because of our strong trade ties with the US, any growth concerns in the US will obviously pressurize the loonie as Canada remains the US’s largest trading partner. With the ‘toing and froing’ of risk attitude, dollar rallies is only giving speculators a better ‘average’ opportunity to own the CAD. It’s difficult to find any technical or fundamental reason to ‘not’ own the currency, whether it’s growth, the BOC attempt to normalize rates somewhat (+0.50%) or as a safer-haven proxy. Longer term speculators continue to wager bets that the CAD will outperform other economies whose monetary policy is expected to experience a prolonged period of near-zero benchmark rates. For most of this month, the loonie has followed equities, in fact, the currency has a +85% correlation with the Dow. Now that the dollar has been able to record a two-month low vs. the EUR, the market will begin to look at the attractiveness of the loonie on the crosses, especially vs. the EUR which has seen a strong gain this week .

The AUD happened to pare its recent gains on speculation that slower Chinese growth will lead to diminished demand for exports from the commodity, growth sensitive and higher yielding country. With Asian regional bourses ending the day in the red has effectively put a lid on the AUD rally, especially now that the JPY has caught a bid on the crosses. It seems that the only immediate concern for the currency could be the looming federal election to be called by new PM Gillard. Currently, there is little evidence that the overall positive sentiment is running out of momentum. Last week we saw that there was nothing better to drag a currency higher than domestic strong employment numbers. That been said, investor confidence and risk tolerance has been changing intraday, making it difficult to formulate a convincing argument in what to do with the currency on a micro-level. 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’. Because of equities actions, the market is a cautious buyer on pullbacks, wary that the recent strong rally technically may be overdone (0.8768).

Crude is little changed in the O/N session ($76.49 -13c). Crude prices remain under pressure after China’s economic growth eased and the Fed said that the ‘US outlook had softened’. The market is concerned about the fuel demand of the world’s two largest energy consuming nations. This week’s inventory report, although headline bullish, has not been able to provide any psychological support. The weekly inventory report fell -5.06m barrels, or -1.4%, to +353.1m (the most in 10-months) vs. an expected decline of only -1.5m barrels. This has left crude supplies +7% above the five-year average for the period. The headline print certainly looks bullish, but, with +350m barrels, supplies are not that tight. Digging deeper, gas supplies climbed +1.6m barrels to +221m, w/w, and not unlike the stocks of distillate fuel (heating oil and diesel), increasing +2.94m barrels to +162.6m, almost three times the size of the gain forecasted. With the dollar also declining vs. the EUR has increased the appeal of commodities as an alternative investment. Analysts believe that the gas markets numbers show ‘lackluster demand and will put pressure on the entire energy complex’. We continue to remain range bound with the price action, as the market is looking for stronger evidence to tackle its resistance levels.

A number of factors have been supporting the ‘yellow metal’s’ this week. Gold is rallying on the heels of positive sentiment expressed by the temporary rally in the equity market, a weaker dollar and finally a Portuguese 2-notch downgrade by Moody’s. Strength in commodities has a positively strong correlation with equities. Pick your poison, as every excuse is legitimate to wanting this commodity to be a part of ones portfolio. Technically, the bullish sentiment had been on hiatus with profit taking testing the medium term support levels. Fundamentally, in the short term the metal will find it difficult to rally aggressively, as historically, this is the ‘slowest’ season for physical demand. Despite this, longer term view, market concerns over global economic growth is supporting the ‘yellow’ metal prices on pull backs. Year-to-date, the commodity has gained +10.5% as investors have been content in using the commodity as a hedge against any European holdings. However, all being said, the commodity needs to close above $1,220 sometime soon to justify any bullish momentum ($1,204 +$3).

The Nikkei closed at 9,408 down -277. The DAX index in Europe was at 6,153 up +4; the FTSE (UK) currently is 5,222 up +10. The early call for the open of key US indices is lower. The US 10-year eased 5bp yesterday (3.00%) and another 2bp in the O/N session (2.98%). Treasuries prices rose on the back of the Fed’s manufacturing reports from Philadelphia and New York cooling, and raising market concerns that the economic recovery is faltering. Surprisingly, weaker US data this week has been offsetting the positive earnings season reports. Fundamental proof that the economy is slowing has investors cautiously grabbing yield. This week’s $69b’s worth of new product was well received and a strong indicator for the medium term investor outlook. Current market sentiment has dealers wanting to be better buyers on pull backs.

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