EURO staring down 1.4500

What will be the EUR high over the next two months? 1.45 Or 1.47? The likely resumption of US QE2 and strong Euro-zone data has the EUR poised to move much higher from the current position by year’s end. The contrarian believes that we are fast approaching the dollar’s sweet spot, where we have everything priced in, preventing it from going much higher. Fresh warning’s from Japanese officials about the strength of the JPY is helping to push the dollar higher this morning, but its gains again will be limited over how big QE2 is going to be. Even the leading candidate for the ECB presidency, Axel Weber, has called for foreign exchange rates to be freely determined and is not concerned about the strength of the EUR. Maybe he has had a little too much of the G20 ‘Kool Aid’!

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 ‘volatile’ trading range.

Forex heatmap

Maybe the market is improving or is it just as easy to lie with statistics? Yesterday’s surprising US housing data temporarily gave the dollar brief support. The number of sales for used homes increased by +10.0%, to an annual rate of +4.53m units. It seems the market has become accustomed to predicting much lower expectations (+5.3% vs. +4.35m). It happened to be the second consecutive monthly increase and is well below where they were a year ago. Year-over-year, existing home sales were down -19.1% from an annual rate of a +5.60m unit pace last Sept. Two positives is not a trend, but it’s a step in the recovery direction. The housing sector has had many strikes against it. The Fed created a subsidy for first-time home buyers to help the sector, but that tax credit expired last spring, causing home sales to plunge. Another black spot against the sector has been the State and Federal investigation into foreclosure practices and the use of ‘robo-signers’. Even the presence of low mortgage rates is not enough to ‘entice would-be home buyers’. With nearly 10% unemployment and high inventories, can only put more pressure on ‘the already depressed home prices’. Inventories fell by -1.9%, m/m to +4m units. That’s a +10.7-month supply at the current sales pace, compared with a +12 in Aug.

The USD$ is higher against the EUR -0.16%, CHF -0.19%, JPY -0.30% and lower against GBP +0.87%. The commodity currencies are weaker this morning, CAD -0.11% and AUD -0.18%. The loonie, along with many of the other majors advanced after a pledge by the G20 finance ministers to avoid ‘competitive devaluation’ failed to dispel speculation that helicopter Ben will ease his announcements on further stimulus measures. In reality, the market seems rather happy strapping on riskier trades. Risk appreciation favors growth and interest rate sensitive currencies like the Canadian and Aussie dollar. That been said, the market should be expecting to see the loonie lag vs. the dollar, despite all the negativity surrounding the greenback. The general pledge to avoid competitive devaluation probably reduces the risk of a trade war. Last 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 next week.

The AUD has taken further strides towards parity after data this week showed that producer prices rose faster (+1.3%) than analysts expected, adding to prospects that the RBA will raise interest rates next month. The market expects CPI to also advance later this week. There is now a +52% chance that the RBA will hike rates at its next meeting on Nov. 2nd. Expectations for the resumption of interest-rate hikes are getting stronger, while there is strong belief that the helicopter Ben will expand credit easing. With this scenario in mind, widening yield differentials continue to support growth sensitive currencies. The currency is also getting a lift from the price of commodities, with the dollar under pressure commodities are advancing. Now that the G20 has given risk ownership the green light again, investors will want to own some growth sensitive currencies. Investors are better buyers on deeper pullbacks as the interest rate differential continues to be of appeal for alternative investments (0.9878).

Crude is lower in the O/N session ($82.01 -51c). Crude futures moved higher yesterday, supported by the continued weakness in the dollar. The market anticipates the Fed to take action to stimulate its own economy will only further pressurize the ‘buck’. Speculators are wagering that the FX market is likely to drive oil prices in the near-term, as investors look for actions by helicopter Ben as the main influence on the fate of economic recovery. It’s expected that growing French demand for imported fuel, due to their domestic strikes, will pressurize inventories elsewhere. Last weeks inventory report again provided crude with a leg up. The headline print rose +667k barrels, less than half what was expected, as total crude stockpiles were to increase by +1.5m barrels. The market also focused 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 were looking for a +0.1% 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. The ‘big’ dollars value continues to push prices about.

Since the completion of the G20 meetings in Korea on the weekend, gold and commodities got the green light to advance as the dollar comes under pressure from all legitimate sources. The yellow metal is a favorite amongst investors as a haven against debasement of the US currency. The dollars negative correlation relationship remains intact with commodity prices. Investors seek an alternative investment strategy to the historical reserve currency. For most of this month the market has traded with a distrust of currencies and gold seemed to be the only solution as investors use 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 (+21.4%), 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 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 ($1,336 -$2.60c).

The Nikkei closed at 9,377 down -24. The DAX index in Europe was at 6,627 down -12; the FTSE (UK) currently is 5,716 -36. The early call for the open of key US indices is higher. The US 10-year eased 3bp yesterday (2.51%) and backed up 5bp in the O/N session (2.58%). Treasuries prices advanced for a second consecutive day ahead of US data this week that is expected to show that domestic growth remains subdued (housing and 3rd Q GDP), and this despite supply coming to the market. Today, the US Treasury will auction $35b worth of 2’s, tomorrow $35b 5’s and Thursday $29b 7’s. Dealers are slowing cheapening the curve to absorb product. It is the sixth straight month that the government has lowered its offering of the three-maturities. The short end is with 3bp of its record low yields on speculation that the Fed is expected to buy $2 trillion of assets to stimulate the economy. Softer data will favor QE2 speculating.

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