Primary objective of the FED

The Fed is doing a good job being the primary source of funding for the Government. Keeping rates at zero and hinting at implementing QE2, like the BOJ, they can push yields lower across the curve. The US government benefits from this exercise when its come to sell its debt. Perhaps the issue of growth and inflation are secondary? Flash PMI weaker than expected this morning continues to weigh on the risk appetite of investors as they sell the EUR and gravitate towards the historical safe heavens. Finally, the Forex market have become bill and bond traders. Watching the Euro-periphery yield spreads balloon to new highs vs. the bund has the market happily implementing risk aversion trading strategies.

The US$ is stronger in the O/N trading session. Currently it is higher against 12 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Forex heatmap

The negative trend continued in the US yesterday. House prices remain on a slippery slope and fell -3.3% in July, y/y or -0.5% from the previous month. It was a bigger than expected decline as the market had been looking for prices to back peddle only -0.2%. Again, the major problem is the rate of foreclosures. They are boosting the supply of available properties and reducing prices, even as mortgage rates tumble to record lows. To clear the backlog of inventory would take +12.5-months, the most ever recorded. Earlier, we saw sales of existing homes in July plunge -27% to a 3.83m pace.

The USD$ is higher against the EUR -0.47%, CHF -0.18%, GBP -0.15% and JPY -0.02%. The commodity currencies are weaker, CAD -0.36% and AUD -0.78%. The loonie gave up its FOMC gains and then some this morning. Partly to blame was the weaker than expected July retail sales report (-0.1% vs. +0.5%) coming in much softer than the market had expected. Consumers pared their purchases of furniture, appliances and electronics. The market is beginning to question the ‘true’ strength of the Canadian Economy after the last few data releases have come in much softer than expected. Global bourses seeing red has reduced the demand of growth currencies. Most of the loonies fall from grace can be attributed to weaker oil prices that are underperforming after the unexpected weekly EIA report yesterday. The weakening dollar index should eventually provide support for the black-stuff. Speculators continue to covet higher yielding growth currencies at lower levels. US/CAD spreads will again dominate the directional play of North American currencies. Month-to-date, spread trades have been the most fundamentally, macro-financial driven reason to want to own the loonie vs. its southern neighbor. A wider spread ‘reflects the improved monetary policy sentiment for Canada’ and is supportive for the currency. The loonie is receiving ‘three-prong’ support, a less dovish BOC, a currency being used as a proxy for growth and to a lesser extent a safer heaven investment. A higher percentage of speculators seem to have missed most of last weeks ‘move’, the market should expect to witness better buying of Canadian dollars on ‘big dollar’ rallies in the short term.

The currency has retreated from its highs as regional bourses see red and profit taking took place. Earlier this week the currency advanced to a two-year high on the belief that the RBA would raise rates while the Fed eases monetary policy further, thus increasing the yield advantage. There is a strong difference in monetary policy stance between Australia and the US and it should eventually provide stronger support for the Aussie. Australia is benefitting from its unilateral trade links with the Chinese economy, its largest trade partner. Not helping the currency will be the forming of a minority government. PM Gillard won the backing of key independent lawmakers this month, allowing her Labor Party to retain government and pursue a ‘tax on mining companies’. Technically, ‘the fiscal outlook looks worse under a minority government and management of an economy growing at +10% in nominal-terms may increasingly rest on the RBA’. The problem, a proposed tax on mining companies will dampen demand for the nation’s assets. If we happen to witness global economic growth decelerating, then we could have the reallocation of funds back out of growth currencies just as quickly as it came in. Until recently, the AUD has gained ground against all of its major trading partners as the ‘vix index’ of volatility softens, boosting investor appetite for assets tied to growth. ‘Clearly what happens in the Australian economy is now more dependent upon what happens in China’. Investors are better buyers on deeper pullbacks (0.9493).

Crude is lower in the O/N session ($74.02 -69c). Crude prices ended yesterday under pressure after a surprising weekly EIA report and global bourses seeing red.The commodity has continued along the same vein this morning. Analysts believe that the higher inventories, coupled with the lack of any significant weather patterns in the Gulf of Mexico, are likely to send crude prices lower in the short term. Crude supplies rose +970k barrels to +358.3m. The market had been expecting a shortfall of -1.75m barrels. Even the dollar print a five month low vs. the EUR has been unable to help the black-stuffs slide. A weaker dollar generally broadens the investment appeal of commodities. Stocks of gas and distillates (heating oil and diesel) also increased unexpectedly. Gas inventories rose by +1.6m barrels, while distillates rose by +300k barrels. Higher inventory supplies have been the biggest inhibitor for a market advance over the past quarter as stockpiles of oil have recorded the highest levels in 27-years. Hence the divergence somewhat of oil and equity markets of late. The market is wary that the underlying situation has not changed, the overall fundamentals remain weak. Analysts expect speculators to remain better sellers on up-ticks in the short term despite the weakness of the dollar.

Gold surged to an all time high for the fifth straight trading session yesterday as a weaker dollar and concern about the sustainable growth of the US economy has investors seeking protection in an asset with a ‘store of value’. Any mentioning of projects to keep the currency low will provide stronger support for the commodity. Year-to-date, the yellow metal has appreciated +18.9%, outperforming most of the other asset classes, as global sovereign-debt concerns and an ‘uneven economic recovery roil financial markets’. With the dollar currently trading at new lows vs. the EUR is also aiding commodity prices. Metals are heading for their 10th consecutive annual gain. Global ‘fear’ has the momentum, again, to push speculators back into this overcrowded, one-directional commodity trade. With the Fed on the verge of implementing further QE programs ‘tend to be supportive of asset prices and is fueling concerns about the potential longer-term inflationary affect of such measures’. The opportunity costs of holding gold are low due to falling interest rates, by default, the market should expect better buying of the metal on pull backs ($1,292 +60c).

The Nikkei closed at 9,566 down -36. The DAX index in Europe was at 6,169 down -39; the FTSE (UK) currently is 5,515 -37. The early call for the open of key US indices is lower. The US 10-year eased 5bp yesterday (2.52%) and is little changed in the O/N session. Yields have tumbled across the curve especially in the short end. Two-year product managed to print a record low return in the last two trading sessions after the Fed’s statement earlier in the week. Helicopter Ben is willing to ease monetary policy to try to boost the US economy and employment. The curve has flattened to its narrowest point in two-weeks (+210bp). Further risk of economic relapse is providing the bid for debt. The market can expect Treasuries to trade within a tight range.

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