G20 Event risk bids dollar higher

Everybody and their mother have been trading the dollar from the short side, betting on further QE in the US. Now with the G20 underway, it’s prudent to lighten their shorts ahead of any event risk. It’s been awhile since the dollar has seen so much interest, two day’s of gains, we know only of one thing and that’s to debase it. It’s believed or ‘leaked’ that G20 ministers plan to say members will refrain from ‘competitive undervaluation‘ of currencies. Certainly not something that will hold up in court, but in reality the market is still unclear ‘if or how’ currencies will be mentioned in the G-20 statement. Providing some support for the EUR this morning was the surprising German ifo business climate index climbing to 107.6 vs. 106.8, and supports Merkel’s bullish growth comments earlier in the week. Data is playing second fiddle to G20 leakage.

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

Forex heatmap

US data yesterday did very little to wake the market out of its intraday slumber. Initial unemployment claims fell by -23k to +452k last week. Although positive, it will hardly be a big enough swing to suggest any improvement in the labor market. It’s worth noting that the previous release was revised up significantly, from +462k to +475k. The four-week moving average fell by -4.2k to +458k. Net effect, the US jobs market remains weak despite the economy gradually expanding over the past year. Continuing claims fell -9k to +4.41m, while the extended (+126k) and emergency claims (+152k- both seasonally adjusted) gave up most of the previous week’s declines. Technically, they have been trading laterally over the month. The unemployment rate among people eligible for benefits, which tends to track the jobless rate, held at +3.5%.

Other data showed that manufacturing in the Philadelphia region expanded, but at an extremely weaker pace, as a measure of orders contracted for a fourth consecutive month. The index of general business activity edged up to +1 vs. market expectations of +2.3. It seems that less inventory rebuilding and consumers constrained by joblessness are restraining factories. Digging deeper into the sub-sectors, one notices that new orders improved to -5 from -8.1 last month, while the shipment index increased to +1.4 from -7.1. The all important job’s sector showed that the employee index rose to +2.4 from +1.8, which is improving the workweek. The downer in the report was the inventory index worsening to -18.6 from -16.7, indicating that businesses continue to cut their ‘goods on hand’, which of course is a blotch on economic growth. The inflation gauge increased, the prices paid index jumped to +31.5 from +9.8, while the prices received reached -9 from -13.9.

The USD$ is higher against the EUR -0.08%, GBP -0.06% and CHF -0.68% and lower against JPY +0.14%. The commodity currencies are mixed this morning, CAD -0.18% and AUD +0.18%. The market should be expecting to see the loonie lag vs. the dollar, despite all the negativity surrounding the greenback. With commodity prices under pressure intraday, by default will always have a negative affect on growth sensitive currencies like the loonie and AUD. Earlier this week Governor Carney stood down on hiking rates as expected, citing a softer outlook for the Canadian economy. Futures prices have priced in a ‘no-hike’ for the next six-months despite policy makers continuing to see the risk to the inflation outlook as being balanced. The BOC said that the ‘more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending’. They did not go all out neutral on future rate hikes, but noted that certain factors stand in the way. A broadly softer dollar on QE2 pressures will prevent the loonie from losing too much ground, until at least after the FOMC meeting in Nov.

The AUD has found some temporary support after Geithner’s said that nations with persistent trade surpluses should use tools including currencies to reduce those imbalances as he headed into this weekend’s G20 meeting. The currency is still heading for a weekly losses on speculation China will announce further measures to slow growth after the nation unexpectedly raised interest rates earlier this week. China is Australia’s largest trading partner. Recent reports show that China’s rate of GDP growth coupled with record inflation acceleration justifies a tighter monetary policy from the PBOC. Providing some weak support was the RBA minutes earlier in the week, which showed that policy maker’s decision to keep interest rates unchanged this month had been ‘finely balanced’. On the other hand they did indicate that rates would have to ‘rise at some point’. From a fundamental perspective the minutes reinforced the argument that there could be another hike coming in Nov. or Dec. given that the RBA seems very comfortable with where the currency is currently. Investors are better buyers on deeper pullbacks as the interest rate differential continues to be of appeal for alternative investments (0.9793).

Crude is higher in the O/N session ($80.96 +40c). Crude prices softened yesterday, as China’s oil processing grew the least in 18-months after government measures to cool the economy reduced fuel consumption. The Chinese’s fuel premium is being discounted somewhat as data verifying slower GDP growth, higher inflation and higher interest rates, are putting a dampener on their economy and the commodity’s recent bullish sentiment.
Data this week showed that the EIA report rose +667k barrels last week, less than half what was expected. Total crude stockpiles were expected to increase by +1.5m barrels. The market is also focusing on the drawdown at Cushing (the delivery point for New York futures). Supplies dropped -1.1m barrels to +34m, the biggest one-week drop in nine-months. Gas stockpiles rose by +1.2m barrels to +219.3m vs. a -1.3m drop. In contrast, distillate stocks (heating oil and diesel) fell by -2.2m to +170.1m barrels. Analysts had expected only a -600k barrel shortfall. The refining capacity utilization rose by +0.6% to +82.5%. Analysts expected a 0.1-percentage point increase. Despite all this, inventories for crude and refined products remain at unusually high levels. Crude analysts note ‘this is currently a shoulder season for product demand ahead of the winter heating season’. Technically, we should see inventories gravitate towards their highs. The market remains wary that the underlying fundamentals have not changed. It’s the dollars value that is pushing prices about.

Gold continues to trade in tandem with the dollar. Its negative correlation relationship remains intact ahead of the G20 meetings in South Korea. The commodity is heading for its first weekly decline in six weeks as a rebound in the dollar is eroding the metal’s appeal as a haven against debasement of the US. On pull backs, investors have been seeking an alternative investment strategy to the historical reserve currency. Interest rates play an important role to the commodities advance. Rising interest rates pressurize gold prices, just look at the markets reaction earlier in the week to China tightening their monetary policy. Year-to-date it has been a commodity in demand for alternative investment purposes. Last week, the market traded with a distrust of currencies and gold seemed to be the only solution as investors used it as a proxy for a ‘third reservable currency’, pushing the metal to record new record highs. With market confidence wavering in currency prices, and with cheap money, has made commodities look attractive on pull backs. To date, gold has outperformed global equities and treasuries (+21.2%), prompting record investment in gold-backed exchange-traded products. The debasing issues of the dollar, coupled with the sustainable growth issues of the US economy have had investors generally seeking protection in an asset with a ‘store of value’. 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 low interest rates ($1,318 -$6.80c).

The Nikkei closed at 9,426 up +50. The DAX index in Europe was at 6,596 down -14; the FTSE (UK) currently is 5,724 -33. The early call for the open of key US indices is lower. The US 10-year backed up 5bp yesterday (2.53%) and is little changed in the O/N session. Treasuries prices fell, pushing the longer dated yields up for the first time this week, after global bourses advanced on the back of stronger US data. It was a combination of US weekly claims falling and leading indicators rising for a third consecutive month had risk aversion trading strategies exiting. Technically it’s been a risk-on 24hours. Also providing some pressure was the Treasury announcing next week’s supply coming to the market ($35b-2’s, $35b-5’s and $29b-7). It will be the sixth straight month that the government has lowered its offering of the three-maturities. It’s the unknown that is keeping yields within a tight range as the open ended questions remain. What form will QE2 take? The market is trying to anticipate how much the Fed will buy or even whether they will give an explicit target. The market remains bid on deeper 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