Bernanke you have got it wrong

Why monetize debt and debase the currency now of all times? The decision is turning into an ‘abysmal failure’. Even before the Fed made their QE2 announcement, data was strengthening and yesterday’s US retail sales even beat market expectations. Albeit slow, the US economy is on the mend. Europe, Japan and the US have all posted solid third quarter growth numbers, where is the collapse in growth? Global yields are aggressively rising. It seems that investors are buying into the growth data while the Fed continues to print money. Their attempt to keep yields low by buybacks is failing, and the dollar is appreciating. Even this mornings stronger than expected German ZEW current conditions print (81.5 vs. 72.6) will pressurize Bunds and Treasuries. That being said, stronger European data is doing little to distract the market from broader matters as we wait on the EU Finance Ministers meeting and US PPI.

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

Yesterday’s US Retail Sales beat market expectations, with headline sales growing +1.2% last month, the most in several months. The market had been expecting a more modest +0.7% gain. Digging deeper, the bulk of the support was found in autos (+5%), building materials (+1.9%) and gas (+0.8%). Core-sales (excluding the three subcategories) were more in line with expectations at +0.2%. It’s this number that the market will focus on, as it will feed consumer distribution directly into GDP. The ‘core’ print caps off the second-consecutive month of decelerating growth. Looking at all the subcategories, gains were widespread, with 9-posted wins and 7-sub-sectors revealing better results than the previous month. Of note, the biggest losers were electronics and furniture. Perhaps this may be seen as stronger proof that consumers are becoming more cautious with their discretionary spending.

In contrast to US Sales, but just as big a surprise, was this months negative Empire Manufacturing Index (-11.4 vs. +15.73). It’s hot on the heels of the previous reports sharp improvement and happens to be the first negative dip in twelve months. All the 9-subcategories deteriorated, with 7-posting negative prints. It’s also worth noting that contractions occurred in prices received, new orders (down -37pts), shipments (-26pts), delivery time, unfilled orders and the average work week. On the bright side, the employment index was the only component to continue to expand, despite it being at a slower pace.

The USD$ is lower against the EUR +0.15%, GBP +0.02%, CHF +0.00% and higher against JPY -0.19%. The commodity currencies are weaker this morning, CAD -0.10% and AUD -0.49%. Yesterday’s session saw the CAD rally for the first time in three days, kicked off by model traders buying the loonie on the crosses and later supported by stronger commodity prices and global bourses in the black. Despite the currency’s attractiveness, it still remains range bound as market sentiment continues to be influenced by European event risk. Even with recent upbeat US data, Governor Carney is expected to keep rates on hold well into the second quarter next year. He said that there are limits in how far Canada rates could diverge from the US. Obviously his decision is based on Bernanke’s QE2 plan to try to keep longer term yields lower to boost growth and eventually inflation. For a commodity supportive currency, the loonie has only appreciated +1.5%, y/d, underperforming other growth currencies. The market is back to embracing the event risk factor and with Euro-peripheral debt problems. It’s interesting that the currency has not received any aftershock from the BHP railroad takeover of Potash by the Federal Govt. Parity is shaping up to be good dollar support first time around.

The AUD trades near its two week low after the RBA minutes for this months meeting. This morning’s report indicated that Governor Stevens decision to raise interest rates was ‘finely balanced’ damping prospects for further increases. Policy makers said a ‘modest tightening’ was considered prudent when they increased the benchmark rate earlier this month (+4.75%). The market now expects the RBA to sit on its hands until next Feb. and the futures market is beginning to price this in. Again in the O/N session, Asian bourses declined on speculation that the Euro-zone will struggle to raise funds and regional risk aversion is evident on the back of China’s pending rate hike. The slump in commodities and the general strength of the dollar has impeded the advance of growth sensitive currencies. Last week’s softer jobs numbers down-under has also justified the unwinding of profitable Aussie positions. The unemployment rate jumped to +5.4% from +5.1%, a six-month high as job seekers swelled to a record, easing concern that a labor shortage will drive up wages. With Chinese authorities demanding higher bank reserves, again will restrict the flow of ‘hot’ money, indirectly and negatively affecting regional bourses and growth currencies. Market players are viewing corrective rebounds as fresh selling opportunities short term (0.9807).

Crude is lower in the O/N session ($84.08 -78c). Oil prices have tried to creep higher after stronger economic indicators out of US and Japan could signal increased fuel demand. Over the past few sessions’ commodities have found it difficult to maintain positive traction on fears that China may attempt to rein in inflation by raising interest rates and curb the commodity demand. The market continues to question the fundamental strength of other economies once the Chinese’s variable is erased from the global growth equation. Last week’s inventory numbers provided little support despite the unexpected decrease in stocks, as imports declined and refineries bolstered fuel production. The supplies of weekly crude fell -3.27m barrels to +364.9m. The market had anticipated inventories to climb +1.5m barrels. Aiding prices was the inventories of gas and distillate fuel (heating oil and diesel) posting bigger-than-projected declines. Gas stocks dropped -1.9m barrels, while distillates fell -5m barrels. Total oil and fuel inventories are now at their lowest levels in six-months after retreating in four of the last five weeks. Refineries operated at 82.4% of capacity, up +0.6%, w/w. Crude-oil imports tumbled -5.7% to +8.09m a day, the lowest level in eleven months. The ‘big’ dollars value will continue to influence prices despite fundamentals.

Gold prices temporarily stopped the bleeding in the morning session yesterday, but, by day’s end happened to reverse any of its earlier gains. When the immediate tightening fear by the PBOC was unfounded and concerns that mounting sovereign debt could erode currencies, boosted demand for the precious metal as an alternative asset. Friday’s price action was the biggest loss the market has incurred in four months. With the one-directional lemming trade, a healthy purge is generally required to eliminate the weak long positions. To a certain extent, the stronger dollar has also curbed the demand for bullion. Speculators should expect European debt concerns to eventually provide support on these pullbacks. With Capital Markets shifting their focus toward sovereign debt issues and away from QE2 debates, should continue to provide support for the asset class on these deep pullbacks. Year-to-date, the metal is up + 23.8% and is poised to record its 10th consecutive annual gain. For most of this year, speculators have sought an alternative investment strategy to the weaker dollar and have been using the commodity as a proxy for a ‘third reservable currency’ ($1,361 -$6.60).

The Nikkei closed at 9,797 down -30. The DAX index in Europe was at 6,756 down -33; the FTSE (UK) currently is 5,751 -69. The early call for the open of key US indices is lower. The US 10-years backed up 16bp yesterday (2.95%) and eased 6bp in the O/N market (2.89%). Treasury prices plummeted yesterday after a surprisingly strong US Retail Sales headline. It temporarily increased market optimism that consumer spending may be improving and adding to the economic recovery. Also aiding higher yields was Richmond’s Fed Lacker stating that they ‘may need to tighten monetary policy even with an elevated unemployment rate to avoid a surge in inflation’. Increased criticism of the Fed’s plan to stimulate growth and concern that a swelling federal deficit has also dragged the curve higher. The market is expecting the Fed to slow down the rapid rise in yields as they implement some of their buy-back in piecemeal everyday this week. Expect more rhetoric from the Fed supporting their plan and stem the rise in yields as yesterday’s $8b longer-term buys seem to have no affect. Market actions continue to see more of the QE2 event risk unwinding the insurance premium we have been pricing in since Aug.

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